Attached files

file filename
EX-32 - EXHIBIT 32 - EMULEX CORP /DE/c95186exv32.htm
EX-31.A - EXHIBIT 31A - EMULEX CORP /DE/c95186exv31wa.htm
EX-31.B - EXHIBIT 31B - EMULEX CORP /DE/c95186exv31wb.htm
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
(Mark One)
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended December 27, 2009
OR
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File No. 001-31353
EMULEX CORPORATION
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction
of incorporation or organization)
  51-0300558
(I.R.S Employer
Identification No.)
     
3333 Susan Street
Costa Mesa, California

(Address of principal executive offices)
  92626
(Zip Code)
(714) 662-5600
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer: þ   Accelerated filer: o   Non-accelerated filer: o   Smaller reporting company: o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of January 21, 2010, the registrant had 80,987,352 shares of common stock outstanding.
 
 

 

 


 

EMULEX CORPORATION AND SUBSIDIARIES
INDEX
         
    PAGE  
 
       
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    19  
 
       
    34  
 
       
    34  
 
       
       
 
       
    34  
 
       
    37  
 
       
    50  
 
       
    50  
 
       
    51  
 
       
    52  
 
       
 Exhibit 31A
 Exhibit 31B
 Exhibit 32

 

2


Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(unaudited, in thousands, except share data)
                 
    December 27,     June 28,  
    2009     2009  
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 252,737     $ 294,136  
Investments
    16,086       8,289  
Accounts and other receivables, net of allowance for doubtful accounts of $1,611 and $1,553 as of December 27, 2009 and June 28, 2009, respectively
    68,207       51,566  
Inventories
    10,717       10,665  
Prepaid income taxes
    17,300       17,083  
Prepaid expenses and other current assets
    9,047       8,021  
Deferred income taxes
    16,289       16,793  
 
           
Total current assets
    390,383       406,553  
 
               
Property and equipment, net
    67,020       74,794  
Goodwill
    87,840       87,840  
Intangible assets, net
    50,143       42,990  
Deferred income taxes
    22,844       16,002  
Other assets
    45,680       30,739  
 
           
Total assets
  $ 663,910     $ 658,918  
 
           
 
               
Liabilities and Stockholders’ Equity
               
 
               
Current liabilities:
               
Accounts payable
  $ 24,834     $ 28,786  
Accrued liabilities
    31,385       23,454  
 
           
Total current liabilities
    56,219       52,240  
 
               
Other liabilities
    5,495       5,826  
Accrued taxes
    32,666       31,408  
 
           
Total liabilities
    94,380       89,474  
 
           
 
               
Commitments and contingencies (Note 8)
               
 
               
Stockholders’ equity:
               
Preferred stock, $0.01 par value; 1,000,000 shares authorized (150,000 shares designated as Series A Junior Participating Preferred Stock); none issued and outstanding
           
Common stock, $0.10 par value; 240,000,000 shares authorized; 90,639,793 and 89,668,255 issued at December 27, 2009 and June 28, 2009, respectively
    9,064       8,967  
Additional paid-in capital
    1,112,464       1,106,990  
Accumulated deficit
    (383,290 )     (396,070 )
Accumulated other comprehensive loss
    (468 )     (443 )
Treasury stock, at cost; 10,550,971 and 8,550,971 shares at December 27, 2009 and June 28, 2009, respectively
    (168,240 )     (150,000 )
 
           
Total stockholders’ equity
    569,530       569,444  
 
           
Total liabilities and stockholders’ equity
  $ 663,910     $ 658,918  
 
           
See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(unaudited, in thousands, except per share data)
                                 
    Three Months Ended     Six Months Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
Net revenues
  $ 108,290     $ 108,661     $ 193,817     $ 220,357  
Cost of sales
    41,506       42,676       74,927       84,420  
 
                       
Gross profit
    66,784       65,985       118,890       135,937  
 
                       
 
                               
Operating expenses:
                               
Engineering and development
    31,680       31,101       63,079       65,884  
Selling and marketing
    15,760       13,270       28,672       27,786  
General and administrative
    11,896       9,548       24,175       18,964  
Amortization of other intangible assets
    1,698       1,851       3,396       3,938  
 
                       
Total operating expenses
    61,034       55,770       119,322       116,572  
 
                       
 
                               
Operating income (loss)
    5,750       10,215       (432 )     19,365  
 
                       
 
                               
Nonoperating (expense) income, net:
                               
Interest income
    93       1,224       212       3,073  
Interest expense
    (2 )     (34 )     (4 )     (36 )
Other (expense) income, net
    (132 )     (127 )     98       197  
 
                       
Total nonoperating (expense) income, net
    (41 )     1,063       306       3,234  
 
                       
 
                               
Income (loss) before income taxes
    5,709       11,278       (126 )     22,599  
 
                               
Income tax (benefit) provision
    (3,233 )     761       (12,906 )     4,581  
 
                       
 
                               
Net income
  $ 8,942     $ 10,517     $ 12,780     $ 18,018  
 
                       
 
                               
Net income per share:
                               
Basic
  $ 0.11     $ 0.13     $ 0.16     $ 0.22  
 
                       
Diluted
  $ 0.11     $ 0.13     $ 0.16     $ 0.22  
 
                       
 
                               
Number of shares used in per share computations:
                               
Basic
    79,667       80,169       79,563       80,604  
 
                       
Diluted
    80,734       80,420       80,505       81,055  
 
                       
See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)
                 
    Six Months Ended  
    December 27,     December 28,  
    2009     2008  
Cash flows from operating activities:
               
Net income
  $ 12,780     $ 18,018  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization of property and equipment
    10,567       10,950  
Share-based compensation expense
    8,564       12,519  
Amortization of intangible assets
    12,847       13,399  
Provision for losses on accounts and other receivables
    58       (36 )
Accrued interest income, net
    37       683  
Loss (gain) on disposal of property and equipment
    769       (94 )
Deferred income taxes
    (8,447 )     (5,570 )
Excess tax benefit from share-based compensation
    (206 )     (188 )
Foreign currency adjustments
    (86 )     (157 )
Changes in assets and liabilities:
               
Accounts and other receivables
    (16,697 )     (3,804 )
Inventories
    (123 )     4,468  
Prepaid expenses and other assets
    (5,971 )     (2,457 )
Accounts payable, accrued liabilities, and other liabilities
    4,684       (9,742 )
Accrued taxes
    1,258       3,319  
Income taxes payable and prepaid income taxes
    (223 )     (52,008 )
 
           
Net cash provided by (used in) operating activities
    19,811       (10,700 )
 
           
 
               
Cash flows from investing activities:
               
Net proceeds from sale of property and equipment
    168       50  
Purchases of property and equipment
    (4,685 )     (14,512 )
Purchases of intangible assets
    (20,000 )      
Investment in and loans to privately-held companies
    (10,000 )     (947 )
Purchases of investments
    (24,585 )     (97,715 )
Maturities of investments
    16,751       176,392  
 
           
Net cash (used in) provided by investing activities
    (42,351 )     63,268  
 
           
 
               
Cash flows from financing activities:
               
Repurchase of common stock
    (18,240 )     (39,913 )
Tax withholding payments reimbursed by common stock
    (3,468 )     (2,416 )
Proceeds from issuance of common stock under stock plans
    2,687       3,850  
Excess tax benefit from share-based compensation expense
    206       188  
 
           
Net cash used in financing activities
    (18,815 )     (38,291 )
 
           
 
               
Effect of exchange rates on cash and cash equivalents
    (44 )     (33 )
 
           
 
               
Net (decrease) increase in cash and cash equivalents
    (41,399 )     14,244  
Cash and cash equivalents at beginning of period
    294,136       217,017  
 
           
Cash and cash equivalents at end of period
  $ 252,737     $ 231,261  
 
           
See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (unaudited)
1.  
Basis of Presentation
In the opinion of management of Emulex Corporation (Emulex or the Company), the accompanying unaudited condensed consolidated financial statements contain all adjustments (which are normal recurring accruals) necessary to present fairly the Company’s consolidated financial position, results of operations, and cash flows. Interim results for the six months ended December 27, 2009, are not necessarily indicative of the results that may be expected for the fiscal year ending June 27, 2010. The accompanying condensed consolidated interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 28, 2009. The preparation of the condensed consolidated financial statements requires the use of estimates and actual results could differ materially from management’s estimates. The Company has evaluated subsequent events through January 29, 2010.
Certain reclassifications have been made to prior period amounts to conform to the current period’s presentation.
Supplemental Cash Flow Information
                 
    Six Months Ended  
    December 27,     December 28,  
    2009     2008  
    (in thousands)  
Cash paid during the period for:
               
Interest
  $ 3     $ 5  
Income taxes
  $ 247     $ 60,905  
 
               
Non-cash activities:
               
Purchases of property and equipment not paid, net
  $ 1,016     $ 779  
Recently Adopted Accounting Standards
In December 2007, the Financial Accounting Standards Board (FASB) issued authoritative guidance for business combinations changing the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and development, and restructuring costs. In addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income taxes. In April 2009, the FASB amended the December 2007 guidance related to the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies assumed in business combinations. The April 2009 guidance eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria and instead carries forward most of the provisions in place before the December 2007 guidance was issued. The December 2007 and April 2009 guidance is effective prospectively for the Company’s fiscal year beginning June 29, 2009, and impacts the accounting for any business combinations entered into after the effective date. There was no financial statement impact of the Company’s adoption of this guidance on June 29, 2009.
In December 2007, the FASB issued authoritative guidance for noncontrolling interests in consolidated financial statements changing the accounting and reporting for minority interests. Minority interests will be recharacterized as noncontrolling interests and will be reported as a component of equity separate from the parent’s equity and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and, upon a loss of control, the interest sold as well as any interest retained will be recorded at fair value with any gain or loss recognized in earnings. This guidance will apply prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. This guidance is effective for the Company’s fiscal year beginning June 29, 2009, and impacts the accounting for and presentation of noncontrolling interests after the effective date. There was no financial statement impact of the Company’s adoption of this guidance on June 29, 2009 as the Company did not have any noncontrolling interests.

 

6


Table of Contents

In December 2007, the FASB ratified Accounting Standard Codification (ASC) 808, “Collaborative Arrangements” that prohibits companies from applying the equity method of accounting to activities performed outside a separate legal entity by a virtual joint venture. Instead, revenues and costs incurred with third parties in connection with the collaborative arrangement should be presented gross or net by the collaborators based on the criteria in previously issued guidance on reporting revenue gross as a principal versus net as an agent and other applicable accounting literature. The consensus should be applied to collaborative arrangements in existence at the date of adoption using a modified retrospective method that requires reclassification in all periods presented for those arrangements still in effect at the transition date, unless that application is impracticable. The consensus is effective for the Company’s fiscal year beginning June 29, 2009. There was no financial statement impact of the Company’s adoption of ASC 808 on June 29, 2009.
In April 2008, the FASB issued authoritative guidance for determining the useful life of intangible assets amending the guidance for estimating the useful lives of recognized intangible assets and requiring additional disclosures related to renewing or extending the terms of recognized intangible assets. This guidance is effective for the Company’s fiscal year beginning June 29, 2009. There was no financial statement impact of the Company’s adoption of this guidance on June 29, 2009.
In June 2008, the FASB issued authoritative guidance for determining whether instruments granted in share-based payment transactions are participating securities. The Company adopted this guidance during the three months ended September 27, 2009. See Note 12.
In November 2008, the FASB issued authoritative guidance for accounting for defensive intangible assets requiring entities to account for a defensive intangible asset as a separate unit of accounting at the time of acquisition, not combined with the acquirer’s existing recognized or unrecognized intangible assets. This consensus is effective for the Company’s fiscal year beginning June 29, 2009, and impacts the accounting for intangible assets acquired after the effective date. There was no financial statement impact of the Company’s adoption of this guidance on June 29, 2009.
In June 2009, the FASB issued ASC 105, “Generally Accepted Accounting Principles” (GAAP), which amends the GAAP hierarchy established under Statement of Financial Accounting Standards (SFAS) No. 162. On July 1, 2009, the FASB launched the FASB Accounting Standards Codification, superseding all existing non-SEC accounting and reporting standards. ASC 105 is effective in the first interim and annual periods ending after September 15, 2009, or the Company’s first quarter of fiscal year 2010 ended September 27, 2009. Following this statement, the FASB will issue new standards in the form of Accounting Standards Updates (ASUs). The Company’s adoption of ASC 105 in the interim period ended September 27, 2009 had no financial statement impact other than the specific references to U.S. GAAP.
Recently Issued Accounting Standards
In September 2009, the FASB issued authoritative guidance for revenue arrangements with multiple deliverables. In the absence of vendor-specific objective evidence (VSOE) or other third party evidence (TPE) of the selling price for the deliverables in certain multiple-element arrangements, companies are required to use an estimated selling price for the individual deliverables. Companies shall apply the relative-selling price model for allocating an arrangement’s total consideration to its individual elements. Under this model, the estimated selling price is used for both the delivered and undelivered elements that do not have VSOE or TPE of the selling price. This consensus will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, or the Company’s 2011 fiscal year. Early adoption is permitted. The Company has not adopted this guidance and is currently assessing the impact of adoption.

 

7


Table of Contents

In September 2009, the FASB issued authoritative guidance for certain revenue arrangements that include software elements amending previous guidance on software revenue recognition to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. This guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, or the Company’s 2011 fiscal year. Early adoption is permitted. The Company has not adopted this guidance and is currently assessing the impact of adoption.
2. Fair Value of Financial Instruments
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. A description of the three levels of inputs is as follows:
             
 
  Level 1     Quoted prices in active markets for identical assets or liabilities;
 
           
 
  Level 2     Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
           
 
  Level 3     Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Financial instruments measured at fair value on a recurring basis as of December 27, 2009 and June 28, 2009 are as follows:
                                 
    Level 1     Level 2     Level 3     Total  
    (in thousands)  
December 27, 2009
                               
Cash and cash equivalents
  $ 252,737     $     $     $ 252,737  
Term deposits
    2,238                   2,238  
U.S. Government securities
    5,496                   5,496  
U.S. Government sponsored entity securities
    8,349                   8,349  
 
                       
 
  $ 268,820     $     $     $ 268,820  
 
                       
 
                               
June 28, 2009
                               
Cash and cash equivalents
  $ 294,136     $     $     $ 294,136  
Municipal bonds
    152                   152  
U.S. Government securities
    4,097                   4,097  
U.S. Government sponsored entity securities
    4,058                   4,058  
 
                       
 
  $ 302,443     $     $     $ 302,443  
 
                       
The Company’s other financial instruments consist primarily of a note receivable, equity investment in privately-held company, and insurance recovery receivable. The Company believes the carrying value of its insurance recovery receivable approximates its current fair value due to its nature and relatively short duration. The fair value of the Company’s investment in privately-held company is not readily available and a reasonable estimate of fair value could not be made without incurring excessive costs. The fair value of the Company’s note receivable is based on management judgment using market-based interest rates, and is believed to approximate its carrying value. The fair value is determined based on “Level 3” inputs which require the use of inputs that are both unobservable and significant to the fair value measurements.

 

8


Table of Contents

3. Investments
The Company’s portfolio of held-to-maturity investments consists of the following:
                                 
            Gross     Gross        
            Unrealized     Unrealized        
    Cost     Gains     Losses     Fair Value  
    (in thousands)  
December 27, 2009
                               
Term deposits
  $ 2,241     $     $ (3 )   $ 2,238  
U.S. Government securities
    5,497             (1 )     5,496  
U.S. Government sponsored entity securities
    8,348       1             8,349  
 
                       
 
  $ 16,086     $ 1     $ (4 )   $ 16,083  
 
                       
 
                               
June 28, 2009
                               
Municipal bonds
  $ 151     $ 1     $     $ 152  
U.S. Government securities
    4,097                   4,097  
U.S. Government sponsored entity securities
    4,041       17             4,058  
 
                       
 
  $ 8,289     $ 18     $     $ 8,307  
 
                       
Investments at December 27, 2009 and June 28, 2009 were classified as short-term investments due to the investments having maturity dates of less than one year.
4. Inventories
Inventories are summarized as follows:
                 
    December 27,     June 28,  
    2009     2009  
    (in thousands)  
 
               
Raw materials
  $ 4,315     $ 4,330  
Finished goods
    6,402       6,335  
 
           
 
  $ 10,717     $ 10,665  
 
           
5. Goodwill and Intangible Assets, net
There was no goodwill activity during the six months ended December 27, 2009.
Intangible assets, net, are as follows:
                 
    December 27,     June 28,  
    2009     2009  
    (in thousands)  
Intangible assets subject to amortization:
               
Core technology and patents
  $ 72,145     $ 92,228  
Accumulated amortization, core technology and patents
    (47,674 )     (82,381 )
Developed technology
    68,500       77,312  
Accumulated amortization, developed technology
    (44,525 )     (46,488 )
Customer relationships
    38,670       38,670  
Accumulated amortization, customer relationships
    (37,548 )     (37,227 )
Tradename
    4,639       4,639  
Accumulated amortization, tradename
    (4,064 )     (3,763 )
 
           
 
  $ 50,143     $ 42,990  
 
           

 

9


Table of Contents

The decrease in core and developed technology during the six months ended December 27, 2009, was primarily due to approximately $48.9 million in core and developed technology being fully amortized and written off. The remaining increase in core technology and patents is due to a patent licensing agreement entered into with a third party for approximately $20.0 million.
The intangible assets subject to amortization are being amortized on a straight-line basis over original lives ranging from approximately five to seven years. Aggregated amortization expense for intangible assets for the three months ended December 27, 2009 and December 28, 2008, was approximately $6.4 million and $6.6 million, respectively. Aggregated amortization expense for intangible assets for the six months ended December 27, 2009 and December 28, 2008, was approximately $12.8 million and $13.4 million, respectively.
Amortization expense of approximately $4.7 million related to core and developed technology is included in cost of sales in the accompanying condensed consolidated statements of income for both the three months ended December 27, 2009 and December 28, 2008. Amortization expense related to core and developed technology included in cost of sales in the accompanying condensed consolidated statements of income for both the six months ended December 27, 2009 and December 28, 2008 was approximately $9.5 million.
The following table presents the estimated future aggregated amortization expense of intangible assets as of December 27, 2009 (in thousands):
         
2010 (remaining 6 months)
  $ 12,847  
2011
    21,711  
2012
    7,585  
2013
    4,000  
2014
    4,000  
Thereafter
     
 
     
 
  $ 50,143  
 
     
6. Other Assets
Components of other assets are as follows:
                 
    December 27,     June 28,  
    2009     2009  
    (in thousands)  
Note receivable
  $ 24,466     $ 15,000  
Equity investment in privately-held company
    11,184       11,184  
Other
    10,030       4,555  
 
           
 
  $ 45,680     $ 30,739  
 
           
In March 2009, the Company loaned $15.0 million to a privately-held company. The note receivable bears simple interest at 5.0% per annum. In December 2009, the Company increased the loan by $10.0 million and extended the maturity date to the earlier of December 31, 2010 or certain defined events such as consummation of financing, change in control, or default. The note receivable is collateralized by substantially all of the assets of the privately-held company.
The Company’s equity investment in a privately-held company is accounted for under the cost method. Under the cost method, investments are carried at cost and are adjusted for other-than-temporary declines in fair value, distributions of earnings, or additional investments. The Company monitors its investment for impairment on a quarterly basis and makes appropriate reductions in carrying values when such impairments are determined to be other-than-temporary. Impairment charges are included in other (expense) income, net in the consolidated statements of income. Factors used in determining an impairment include, but are not limited to, the current business environment including competition; uncertainty of financial condition; technology and product prospects; results of operations; and current financial position including any going concern considerations such as the rate at which the investee utilizes cash and the investee’s ability to obtain additional financing. The Company has determined that there is no impairment as of December 27, 2009. However, it is considered reasonably possible that the Company’s determination that there is no impairment could change if the current business environment deteriorates, if the investees’ financial condition worsens, or the investee is unable to secure adequate financing to support its business plan and operations.

 

10


Table of Contents

7. Accrued Liabilities
Components of accrued liabilities are as follows:
                 
    December 27,     June 28,  
    2009     2009  
    (in thousands)  
Payroll and related costs
  $ 17,125     $ 11,410  
Warranty liability
    1,926       2,462  
Deferred revenue and accrued rebates
    3,939       3,499  
Other
    8,395       6,083  
 
           
 
  $ 31,385     $ 23,454  
 
           
The Company provides a warranty of between one and five years on its products. The Company records a provision for estimated warranty-related costs at the time of sale based on historical product return rates and the Company’s estimates of expected future costs of fulfilling its warranty obligations. Changes to the warranty liability were:
         
    (in thousands)  
Balance as of June 28, 2009
  $ 2,462  
Accrual for warranties issued
    488  
Changes to pre-existing warranties (including changes in estimates)
    (461 )
Settlements made (in cash or in kind)
    (563 )
 
     
Balance as of December 27, 2009
  $ 1,926  
 
     
8. Commitments and Contingencies
Litigation
On November 15, 2001, prior to the Company’s acquisition of Vixel Corporation, a securities class action was filed in the United States District Court in the Southern District of New York as Case No. 01 CIV. 10053 (SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers and directors (one of which is James M. McCluney, the Company’s current Chief Executive Officer and President) and certain underwriters who participated in the Vixel initial public offering in late 1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section 11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties agreed to toll the statute of limitations with respect to Vixel’s officers and directors until September 30, 2003, and on the basis of this agreement, Vixel’s officers and directors were dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer defendants in the action reached a tentative settlement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the defendants and their officers and directors. In connection with the possible settlement, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements so that they would not expire prior to any settlement being finalized. Although Vixel approved this settlement proposal in principle, it remained subject to a number of procedural conditions, as well as formal approval by the court. On August 31, 2005, a Preliminary Order In Connection With Settlement Proceedings was issued by the court which among other items, set a date for a Settlement Fairness Hearing held on April 24, 2006, and the form of notice to the Settlement Classes of the Issuers’ Settlement Stipulation. In December 2005, the settlement notices authorized by the court were sent to former Vixel stockholders and the web site www.iposecuritieslitigation.com was created for claimants, as well as a March 24, 2006 objection deadline. At the Settlement Fairness Hearing held on April 24, 2006, the court raised the following primary issues: (1) the (possible) change in value of the settlement since preliminary approval, and whether the benefits of the

 

11


Table of Contents

settlement should be evaluated at the time of approval or at the time of negotiation; (2) how the class certification argument before the Second Circuit Court of Appeals could or would affect the fairness of the settlement; (3) how to evaluate the intangible benefits of the settlement to the class members; and (4) how to value the $1 billion guarantee (for the consolidated litigation involving Vixel and 297 other Issuers) by insurers in the stipulation and agreement of settlement in light of the underwriters’ potential future settlements. The Court did not rule on April 24, 2006 on the motion for final approval or objections. On June 6, 2006, the Second Circuit Court of Appeals held oral arguments on the appeal by the underwriters of Judge Scheindlin’s class certification decision. On or about July 17, 2006, Emulex assigned to the class action plaintiffs any IPO claims that Emulex (Vixel) had against RBC Dain Rauscher in the IPO litigation, as required by the settlement agreement. On December 5, 2006, the Second Circuit Court of Appeals issued a decision reversing Judge Scheindlin’s class certification decision. On December 14, 2006, Judge Scheindlin issued an order to stay all proceedings pending a decision from the Second Circuit on whether it will hear further argument. On about January 6, 2007, Emulex assigned to the class action plaintiffs any IPO claims that Emulex (Vixel) had against The Bear Stearns Companies Inc. and Bear Stearns & Co. Inc. in the IPO litigation, as required by the settlement agreement. On April 6, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of the decision denying class certification. During April 2007, counsel for Emulex and other Issuers informed Judge Scheindlin that, in light of the Second Circuit opinion, the settlement agreement could not be approved because the defined settlement class, like the litigation class, did not meet the Second Circuit requirements for certification. Judge Scheindlin held a conference on May 30, 2007 to consider issues relating to the class definitions, the statute of limitations, settlement, and discovery. On June 25, 2007, Judge Scheindlin signed a Stipulation and Order submitted by the parties which terminated the June 10, 2004 Stipulation and Agreement of Settlement with Defendant Issuers and Individuals. On June 26, 2007, a document production request from the plaintiffs to all 298 issuers (including Vixel) was received, covering documents from each issuer’s inception through December 31, 2001. In September 2007, due to the expiration of the tolling agreements, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements until August 27, 2010. On November 15, 2007, the issuers and their respective insurers entered into an Insurers-Insureds Agreement (replacing an earlier agreement), which provides for the insurers to pay for certain defense costs under applicable issuer insurance policies. On December 21, 2007, issuer defendants filed an opposition to plaintiffs’ motion for class certification of certain focus cases. On March 26, 2008, defendants’ motion to dismiss was denied except to certain claims by plaintiffs who did not suffer damages or whose claims were time barred. On Oct. 10, 2008, Judge Scheindlin signed an order granting the plaintiffs’ request to withdraw the class certification motion in the six focus cases (Emulex/Vixel is not in a focus case). On April 1, 2009, the parties signed a Stipulation and Agreement of Settlement (the 2009 Settlement) which the District Court subsequently approved on October 6, 2009. The 2009 Settlement provides for a settlement amount of $586 million, and Emulex has no obligation to pay any part of that amount. On October 23, 2009, Lester Baum, Mike Hart, and Sue Shadley filed a petition for permission to appeal the class certification order.
On January 27, 2009, a patent infringement lawsuit was filed in the United States District Court in the Central District of California as Case No. CV09-00605 R (JWJx) against Emulex by Microprocessor Enhancement Corporation and Michael H. Branigin. The complaint alleges infringement of U.S. Patent No. 5,471,593, and seeks a judgment for damages, injunctive relief, and an award of attorneys’ fees and costs. On March 25, 2009, Emulex filed an answer to the complaint denying allegations and asserting affirmative defenses. On Oct. 13, 2009, the Company filed documents opposing a summary judgment motion by the Plaintiffs. A hearing of the summary judgment motion was held on Nov. 16, 2009, and the motion was taken under submission.
On April 27, 2009, Reid Middleton filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of himself and all other similarly situated stockholders of the Company and derivatively on behalf of the Company. The original complaint named the members of the Board as defendants and the Company as a nominal defendant. The complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of shares of the Company’s common stock (the Shares) and a derivative claim for devaluation of the Company stemming from the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its unsolicited April 21, 2009 takeover proposal to acquire the Company. The original complaint sought declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.

 

12


Table of Contents

On May 6, 2009, Jim Robbins filed a lawsuit in the Superior Court of the State of California, County of Orange, on behalf of himself and all other similarly situated stockholders of the Company (the California Litigation). The complaint names the members of the Board and the Company as defendants. The complaint asserts a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory and injunctive relief, a constructive trust upon any benefits improperly received as a result of the alleged wrongful conduct and breach of any duty owed to the holders of Shares, and costs, including attorneys’ and expert fees. This lawsuit was dismissed without prejudice on December 15, 2009.
On May 7, 2009, Kamwai Fred Chan filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of himself and all other similarly situated stockholders of the Company. The complaint names the members of the Board and the Company as defendants. The complaint asserts a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.
On May 11, 2009, the Court of Chancery of the State of Delaware granted plaintiff Reid Middleton’s motion to expedite proceedings and set a trial date in the three foregoing Delaware lawsuits beginning on July 8, 2009. On July 6, 2009, the Court of Chancery continued the July 8, 2009 trial date indefinitely. On December 3, 2009, the plaintiff’s attorneys filed an application for an award of attorney’s fees and expenses. The Court rejected the plaintiff’s request for attorneys’ fees on December 18, 2009.
On May 11, 2009, Pipefitters Local No. 636 Defined Benefit Plan filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of itself and all other similarly situated stockholders of the Company and derivatively on behalf of the Company. The original complaint named the members of the Company’s Board as defendants and the Company as a nominal defendant. The complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The original complaint also asserted a derivative claim for breach of fiduciary duty based on the same actions. The original complaint sought declaratory and injunctive relief, including mandatory injunctive relief, and costs, including attorneys’ and expert fees.
On May 12, 2009, Norfolk County Retirement System filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of itself and all other similarly situated stockholders of the Company. The original complaint named the members of the Company’s Board and the Company as defendants. The original complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The original complaint sought declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.
On September 17, 2009, Reid Middleton, Pipefitters Local No. 636 Defined Benefit Plan and Norfolk County Retirement System (together the Plaintiffs) filed a Verified Amended Class Action and Derivative Complaint in the Court of Chancery of the State of Delaware. The amended complaint is brought on behalf of Plaintiffs and all other similarly situated stockholders of the Company and, alternatively, derivatively on behalf of the Company. The complaint names the members of the Board as defendants and the Company as a nominal defendant. The complaint asserts claims for breach of fiduciary duty on behalf of a putative class of holders of Shares and, alternatively, a derivative claim for devaluation of the Company stemming from the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory relief, compensatory damages, interest and costs, including attorneys’ and expert fees. On October 13, 2009, the defendants filed an answer to the amended complaint.

 

13


Table of Contents

On September 14, 2009, Broadcom Corporation filed a patent infringement lawsuit against the Company in the United States District Court, in the Central District of California. The suit alleges that the Company is infringing 10 Broadcom patents covering certain data and storage networking technologies. The complaint seeks declaratory and injunctive relief, monetary damages, and interest and costs, including attorneys’ and expert fees. On November 4, 2009, the Company filed its answer and affirmative defenses to the patent infringement complaint alleging that it believes that the Broadcom patents at issue are invalid or not infringed, or both. In addition, the Company asserted counterclaims for declaratory judgment of invalidity and non-infringement against each of the Broadcom patents at issue, and seeks award of attorneys’ fees, costs, and expenses. On January 11, 2010, the Court set a trial date of September 20, 2011.
On November 9, 2009, the Company filed a lawsuit against Broadcom Corporation alleging that Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws, as well as made defamatory statements and engaged in acts of unfair competition. The complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief against Broadcom. On January 4, 2010, the Company filed an amended complaint. The amended complaint alleges that Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws and made defamatory statements. The amended complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief. Broadcom’s response to the amended complaint is due to be filed on February 4, 2010.
In addition to the ongoing litigation discussed above, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of the open matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.
Broadcom Unsolicited Takeover Proposal
Broadcom Corporation initiated an unsolicited takeover proposal of $9.25 per share to purchase all the common shares of the Company on May 5, 2009. On June 30, 2009, Broadcom Corporation increased its offer price to $11.00 per share and extended the expiration of the tender offer period to July 14, 2009. On July 9, 2009, Broadcom Corporation announced it would cease further efforts to acquire the Company. On July 14, 2009, Broadcom Corporation’s tender offer expired without further action.
Other Commitments and Contingencies
The Company has approximately $32.5 million of unrecognized tax benefits as of December 27, 2009 for which a reasonably reliable estimate of the period of payment cannot be made.
The Company has entered into various agreements for purchases of inventory. As of December 27, 2009, the Company’s purchase obligation associated primarily with inventory was approximately $38.1 million.
In addition, the Company provides limited indemnification in selected circumstances within its various customer contracts whereby the Company indemnifies the parties to whom it sells its products with respect to the Company’s product infringement of certain intellectual property, and in some limited cases against bodily injury or damage to real or tangible personal property caused by a defective Company product. It is not possible to predict the maximum potential amount of future payments under these or similar agreements, due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. As of December 27, 2009, the Company has not incurred any significant costs related to indemnification of its customers.

 

14


Table of Contents

9. Treasury Stock
In early August 2008, the Company’s Board of Directors authorized a plan to repurchase up to $100.0 million of its outstanding common stock. In April 2009, upon receipt of an unsolicited acquisition proposal and related tender offer of Broadcom Corporation to acquire the Company, the Company’s Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom’s announcement of its decision to allow its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. During the six months ended December 27, 2009, the Company has repurchased 2.0 million shares of its common stock for an aggregate purchase price of approximately $18.2 million or an average of $9.12 per share under this plan. The Company may repurchase shares from time-to-time in open market purchases or privately negotiated transactions. The share repurchases will be financed by available cash balances and cash from operations. The Company’s Board of Directors has not set an expiration date for the plan.
10. Stock-Based Compensation
As of December 27, 2009, the Company had three stock-based plans for employees and directors that are open for future awards, the 2005 Equity Incentive Plan (Equity Incentive Plan), the 1997 Stock Award Plan for Non-Employee Directors (Director Plan), and the Emulex Corporation Employee Stock Purchase Plan (Purchase Plan). In addition, the Company had eight stock-based plans (All Other Plans), including six plans assumed in connection with prior acquisitions, each of which is closed for future grants but has options outstanding. Available for future awards are 4,633,638 shares under the Equity Incentive Plan, 271,000 shares under the Director Plan, and 1,008,061 shares under the Purchase Plan.
Aggregate amounts recognized in the condensed consolidated financial statements with respect to these plans are as follows:
                                 
    Three Months     Three Months     Six Months     Six Months  
    Ended     Ended     Ended     Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
    (in thousands)  
Total cost of stock-based payment plans during the period
  $ 3,590     $ 5,735     $ 8,493     $ 12,518  
Amounts capitalized in inventory during the period
    (83 )     (165 )     (203 )     (344 )
Amounts recognized in income for amounts previously capitalized in inventory
    120       179       274       345  
 
                       
Amounts charged against income, before income tax benefit
  $ 3,627     $ 5,749     $ 8,564     $ 12,519  
 
                       
Amount of related income tax benefit recognized in income, excluding tax impact of stock option exchange program (see Note 11)
  $ 1,438     $ 1,574     $ 3,067     $ 3,490  
 
                       
The fair value of each stock option award under the Equity Incentive Plan and the Director Plan and purchase under the Purchase Plan is estimated on the date of grant using the Black-Scholes option-pricing model based on the market price of the underlying common stock on the date of grant, expected term, stock price volatility and expected risk-free interest rates. Expected volatilities are based on methodologies utilizing equal weighting involving both historical periods equal to the expected term and implied volatilities based on traded options to buy the Company’s shares. The fair value of each unvested stock award is determined based on the closing price of the Company’s common stock on the grant date.

 

15


Table of Contents

The assumptions utilized to compute the fair value of stock option grants under the Equity Incentive Plan and the Director Plan for the three and six months ended December 27, 2009 and December 28, 2008 were:
                 
    Three Months Ended   Six Months Ended
    December 27,   December 28,   December 27,   December 28,
    2009   2008   2009   2008
Expected volatility
  46% — 49%   50% — 51%   46% — 49%   42% — 51%
Weighted average expected volatility
  48%   51%   47%   43%
Expected dividends
       
Expected term (in years)
  2.97 — 4.97   2.97 — 4.97   2.97 — 4.97   2.97 — 4.97
Weighted average expected term (in years)
  3.81   3.81   3.81   3.81
Risk-free rate
  1.49% — 2.50%   1.12% — 1.50%   1.49% — 2.50%   1.12% — 3.02%
The assumptions utilized to compute the fair value of the compensatory element related to the shares to be purchased under the Purchase Plan for the three and six months ended December 27, 2009 and December 28, 2008 were:
                                 
    Three Months Ended     Six Months Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
Expected volatility
    43 %     49 %     43 %     49 %
Expected dividends
                       
Expected term (in years)
    0.49       0.5       0.49       0.5  
Risk-free rate
    0.17 %     1.13 %     0.17 %     1.13 %
A summary of option activity under the plans for the six months ended December 27, 2009 is as follows:
                                 
                    Weighted        
                    Average        
            Weighted     Remaining     Aggregate  
            Average     Contractual     Intrinsic  
    Options     Exercise Price     Term     Value  
                    (in years)     (in millions)  
Options outstanding at June 28, 2009
    12,180,404     $ 21.68       3.10     $ 2.0  
Options granted
    423,000     $ 9.81                  
Options exercised
    (26,973 )   $ 2.73                  
Options canceled
    (4,159,933 )   $ 22.83                  
Options forfeited
    (495,744 )   $ 16.98                  
 
                             
Options outstanding at December 27, 2009
    7,920,754     $ 20.81       3.04     $ 2.7  
 
                             
Options vested and expected to vest at December 27, 2009
    7,853,859     $ 20.89       3.02     $ 2.6  
 
                             
Options exercisable at December 27, 2009
    7,102,489     $ 21.79       2.82     $ 2.1  
 
                             
A summary of unvested stock awards activity for the six months ended December 27, 2009 is as follows:
                 
            Weighted  
            Average Grant  
    Number of     Date Fair  
    Awards     Value  
Awards outstanding and unvested at June 28, 2009
    2,721,606     $ 12.85  
Awards granted
    1,521,008     $ 8.66  
Awards vested
    (988,460 )   $ 15.48  
Awards forfeited
    (161,618 )   $ 14.15  
 
             
Awards outstanding and unvested at December 27, 2009
    3,092,536     $ 9.88  
 
             
As of December 27, 2009, there was approximately $19.4 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans. That cost is expected to be recognized over a weighted-average period of approximately 1.4 years.

 

16


Table of Contents

The weighted average grant date fair value of options granted during the six months ended December 27, 2009 and December 28, 2008 was approximately $3.69 per share and $4.15 per share, respectively. The weighted average grant date fair value of unvested stock awards granted during the six months ended December 27, 2009 and December 28, 2008 was approximately $8.66 per share and $10.36 per share, respectively. The total intrinsic value of stock options exercised was approximately $0.2 million and $1.1 million for the six months ended December 27, 2009 and December 28, 2008, respectively. The total fair value of unvested stock awards that vested during the six months ended December 27, 2009 and December 28, 2008 was approximately $9.8 million and $6.9 million, respectively. Cash received from stock option exercises under stock-based plans and shares purchased under the Purchase Plan was approximately $2.7 million for the six months ended December 27, 2009 and approximately $3.8 million for the six months ended December 28, 2008. The actual tax benefit realized for tax deductions from option exercises was approximately $3.8 million and $3.0 million for the six months ended December 27, 2009 and December 28, 2008, respectively.
On July 14, 2009, the Company completed the option exchange program approved by shareholders at Emulex’s Annual Shareholders Meeting on November 19, 2008. There were 3,925,263 options cancelled in exchange for a total of 225,783 unvested stock units granted to 379 employees. In connection with the option exchange program, the Company is required to recognize incremental share-based compensation expense over the remaining vesting period, if the number of shares underlying the restricted stock units multiplied by the last reported sales price of the Company’s common stock on the grant date of the restricted stock units exceeds the fair value of the eligible options immediately before their cancellation. The expense related to the option exchange program was negligible.
As of December 27, 2009, we anticipate that the number of shares authorized under the Equity Incentive Plan, the Director Plan, the Purchase Plan, and All Other Plans are sufficient to cover future stock option exercises and shares that will be purchased during the next six month option period from November 1, 2009 to April 30, 2010 under the Purchase Plan.
11. Income Taxes
The Company recorded an income tax benefit of approximately $12.9 million and an income tax provision of approximately $4.6 million for the six months ended December 27, 2009 and December 28, 2008, respectively. Due to the current economic climate, forecasting for fiscal 2010 is subject to significant change and projection of an annual effective tax rate for the year is not appropriate. Therefore, the quarterly provision was calculated using the year to date actual results for the six months ended December 27, 2009. The effective tax benefit rate was approximately 10,243% for the six months ended December 27, 2009 and the effective tax rate was approximately 20% for the six months ended December 28, 2008. The tax benefit in the current year was primarily generated from pre-tax losses in the United States, implementation of a stock option exchange program, and savings from Federal and state research credits. The Company’s effective tax rate depends on various factors, such as tax legislation, the mix of domestic and international pre-tax income, research and development credits as a percentage of aggregate pre-tax income, and the effectiveness of the Company’s tax planning strategies.
During the six months ended December 27, 2009, income taxes included a benefit of approximately $4.0 million related to the stock option exchange program. The tax benefit is primarily due to the recovery of income tax expense previously recognized related to certain incentive stock options exchanged for restricted stock units as part of the program.
12. Net Income Per Share
In June 2008, the FASB issued authoritative guidance for whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (EPS) under the two-class method described in previously issued guidance for EPS. This guidance is effective for fiscal years, and interim reporting periods within those fiscal years, beginning after December 15, 2008, which was the Company’s fiscal year beginning June 29, 2009. Upon adoption, EPS data for all periods presented were adjusted to conform to the authoritative guidance.

 

17


Table of Contents

Basic net income per share for the three and six months ended December 27, 2009 and December 28, 2008, was computed by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding during the period.
Diluted net income per share was computed by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would be outstanding if the dilutive potential common shares from stock-based plans had been issued. The dilutive effect of outstanding stock options and stock awards is reflected in diluted net income per share by application of the treasury stock method. The following table sets forth the computation of basic and diluted net income per share:
                                 
    Three Months Ended     Six Months Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
    (in thousands, except per     (in thousands, except per  
    share data)     share data)  
 
                               
Numerator — Net income
  $ 8,942     $ 10,517     $ 12,780     $ 18,018  
Less: Undistributed earnings allocated to participating securities
    (111 )     (272 )     (210 )     (465 )
 
                       
Undistributed earnings allocated to common shareholders for basic net income per share
  $ 8,831     $ 10,245     $ 12,570     $ 17,553  
 
                       
Undistributed earnings allocated to common shareholders for diluted net income per share
  $ 8,832     $ 10,245     $ 12,573     $ 17,555  
 
                       
 
                               
Denominator:
                               
Denominator for basic net income per share — weighted average shares outstanding
    79,667       80,169       79,563       80,604  
Effect of dilutive securities:
                               
Dilutive options outstanding, unvested stock units and ESPP
    1,067       251       942       451  
 
                       
Denominator for diluted net income per share — adjusted weighted average shares outstanding
    80,734       80,420       80,505       81,055  
 
                       
 
                               
Basic net income per share
  $ 0.11     $ 0.13     $ 0.16     $ 0.22  
 
                       
Diluted net income per share
  $ 0.11     $ 0.13     $ 0.16     $ 0.22  
 
                       
Antidilutive options and unvested stock excluded from the computations
    8,338       15,787       8,987       15,292  
 
                       
Average market price of common stock
  $ 10.55     $ 7.86     $ 10.09     $ 10.02  
 
                       
The antidilutive stock options and unvested stock were excluded from the computation of diluted net income per share due to the assumed proceeds from the award’s exercise or vesting being greater than the average market price of the common shares for the periods presented.

 

18


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements contained in this Form 10-Q may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, our representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “anticipates,” “in the opinion,” “believes,” “intends,” “expects,” “may,” “will,” “should,” “could,” “plans,” “forecasts,” “estimates,” “predicts,” “projects,” “potential,” “continue,” and similar expressions may be intended to identify forward-looking statements.
Actual future results could differ materially from those described in the forward-looking statements as a result of a variety of factors, including those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and, in particular, those in the section entitled “Risk Factors” in Part II, Item 1A of this Form 10-Q included elsewhere herein. We expressly disclaim any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances. We wish to caution readers that a number of important factors could cause actual results to differ materially from those in the forward-looking statements. The fact that the uncertainty of the economy generally, and the technology and storage segments specifically, have been in a state of uncertainty makes it difficult to determine if past experience is a good guide to the future and makes it impossible to determine if markets will grow or shrink in the short term. The recent economic downturn and the resulting economic uncertainty for our customers and the storage networking market as a whole has resulted in a decrease in information technology spending that has and could continue to adversely affect our revenues and results of operations. Furthermore, the effect of any actual or potential unsolicited offers to acquire us may have an adverse effect on our operations. As a result of this uncertainty, we are unable to predict with any accuracy what future results might be. Other factors affecting these forward-looking statements include, but are not limited to, the following: slower than expected growth of the storage networking market or the failure of our Original Equipment Manufacturer (OEM) customers to successfully incorporate our products into their systems; our dependence on a limited number of customers and the effects of the loss of, or decrease or delays in orders by, any such customers, or the failure of such customers to make payments; the emergence of new or stronger competitors as a result of consolidation movements in the market; the timing and market acceptance of our or our OEM customers’ new or enhanced products; the variability in the level of our backlog and the variable and seasonal procurement patterns of our customers; impairment charges, including but not limited to goodwill, intangible assets, and equity investments recorded under the cost method; changes in tax rates or legislation; the effects of acquisitions; the effects of terrorist activities, natural disasters and any resulting political or economic instability; the highly competitive nature of the markets for our products as well as pricing pressures that may result from such competitive conditions; the effect of rapid migration of customers towards newer, lower cost product platforms; possible transitions from board or box level to application specific computer chip solutions for selected applications; a shift in unit product mix from higher-end to lower-end or mezzanine card products; a decrease in the average unit selling prices or an increase in the manufactured cost of our products; delays in product development; our reliance on third-party suppliers and subcontractors for components and assembly; any inadequacy of our intellectual property protection or the potential for third-party claims of infringement; our ability to attract and retain key technical personnel; our ability to benefit from our research and development activities; our dependence on international sales and internationally produced products; changes in accounting standards; and the potential effects of global warming and any resulting regulatory changes on our business. These and other factors which could cause actual results to differ materially from those in the forward-looking statements are discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated therein by reference.

 

19


Table of Contents

Executive Overview
Emulex creates enterprise-class products that connect storage, servers and networks. We are a leading supplier of a broad range of advanced storage networking convergence solutions. The world’s leading server and storage providers depend on our products to help build high performance, highly reliable, and scalable storage networking solutions. Our products and technologies leverage flexible multi protocol architectures that extend from deep within the storage array to the server edge of storage area networks (SANs).
Our Company operates within a single business segment that has two market focused product lines — Host Server Products (HSP) and Embedded Storage Products (ESP). HSP includes both Fibre Channel based connectivity products and Enhanced Ethernet based products that support Internet Protocol (IP) and storage networking, including Transmission Control Protocol (TCP)/IP, Internet Small Computer System Interface (iSCSI), Network Attached Storage (NAS) and Fibre Channel over Ethernet (FCoE). Our Fibre Channel based products include LightPulse® HBAs, custom form factor solutions for OEM blade servers and application specific integrated circuits (ASICs). These products enable servers to efficiently connect to SANs by offloading data communication processing tasks from the server as information is delivered and sent to the storage network. Our Enhanced Ethernet based products include OneConnect Universal Converged Network Adapters (UCNAs) that enable network convergence.
ESP includes our InSpeed, FibreSpy®, IOC solutions, switch-on-a-chip (SOC) and bridge and router products. Embedded storage switches, bridges, routers, and IOCs are deployed inside storage arrays, tape libraries, and other storage appliances, connect storage controllers to storage capacity delivering improved performance, reliability, and storage connectivity.
Our Other category primarily consists of contract engineering services, legacy and other products.
We rely almost exclusively on OEMs and sales through distribution channels for our revenue. Our OEM customers include the world’s leading server and storage providers, including Dell Inc. (Dell), EMC Corporation (EMC), Fujitsu Ltd. (Fujitsu), Groupe Bull (Bull), Hewlett-Packard Company (Hewlett-Packard), Hitachi Data Systems (HDS), Hitachi Limited (Hitachi), International Business Machines Corporation (IBM), LSI Corporation (LSI), NEC Corporation (NEC), Network Appliance, Inc. (NetApp), Quantum Corporation (Quantum), Sun Microsystems, Inc. (Sun), Unisys Corporation (Unisys), and Xyratex Ltd. (Xyratex). Our distribution partners include Arrow ECS Denmark A/S (Arrow), Avnet, Inc. (Avnet), Bell Microproducts, Ltd. (Bell), Info X Distribution, LLC (Info X), Ingram Micro Inc. (Ingram Micro), Macnica Networks Corporation (Macnica), Netmarks Inc. (Netmarks), Tech Data Corporation (Tech Data), and Tokyo Electron Device Ltd. (TED). The market for storage networking infrastructure solutions is concentrated among large OEMs, and as such, a significant portion of our revenues are generated from sales to a limited number of customers.
The recent economic downturn and related economic uncertainty for our customers and the storage networking market as a whole has resulted in a downturn in information technology spending that has and could continue to adversely affect our revenues and results of operations. As a result of this uncertainty, we plan to continue to closely manage our controllable expenses while investing in research and development, sales and marketing, capital equipment, and facilities in order to achieve our growth and market leadership goals. As of December 27, 2009, we had a total of 765 employees.
Our corporate headquarters are located at 3333 Susan Street, Costa Mesa, California 92626. Our periodic and current reports filed with, or furnished to, the Securities and Exchange Commission pursuant to the requirements of the Securities and Exchange Act of 1934 are available free of charge through our website (www.emulex.com) as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. References contained herein to “Emulex,” the “Company,” the “Registrant,” “we,” “our,” and “us” refer to Emulex Corporation and its subsidiaries.

 

20


Table of Contents

Global Initiatives
As part of our global initiatives, we created an Irish subsidiary to expand our international operations by providing local customer service and support to our customers outside of the United States in the fourth quarter of fiscal 2008. In addition, Emulex granted an intellectual property license and entered into a research and development cost sharing agreement with a newly formed subsidiary in the Isle of Man. The terms of the license require that the subsidiary make prepayments of expected royalties to a U.S. subsidiary, the first of which was paid before the end of fiscal 2008 in the amount of approximately $131.0 million, for expected royalties relating to fiscal 2009 through 2015. These global initiatives are expected to significantly reduce our effective tax rate beginning with fiscal 2010.
Our cash balances and investments are held in numerous locations throughout the world. The cash and investments held outside of the U.S. are expected to increase, primarily in our Isle of Man and Ireland subsidiaries. Substantially all of the amounts held outside of the U.S. will be available for repatriation at any time, but under current law, repatriated funds would be subject to U.S. federal income taxes, less applicable foreign tax credits.
Results of Operations
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements included elsewhere herein.
                                 
    Percentage of Net Revenues     Percentage of Net Revenues  
    Three Months Ended     Six Months Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
Net revenues
    100 %     100 %     100 %     100 %
Cost of sales
    38       39       39       38  
 
                       
Gross profit
    62       61       61       62  
 
                       
Operating expenses:
                               
Engineering and development
    29       28       33       30  
Selling and marketing
    15       12       15       13  
General and administrative
    11       9       12       8  
Amortization of other intangible assets
    2       2       2       2  
 
                       
Total operating expenses
    57       51       62       53  
 
                       
Operating income (loss)
    5       10       (1 )     9  
 
                       
Nonoperating (expense) income, net:
                               
Interest income
          1             1  
Interest expense
                       
Other (expense) income, net
                       
 
                       
Total nonoperating (expense) income, net
          1             1  
 
                       
Income (loss) before income taxes
    5       11       (1 )     10  
 
                       
Income tax (benefit) provision
    (3 )     1       (7 )     2  
 
                       
Net income
    8 %     10 %     6 %     8 %
 
                       

 

21


Table of Contents

Three months ended December 27, 2009, compared to three months ended December 28, 2008
Net Revenues. Net revenues for the second quarter of fiscal 2010 ended December 27, 2009, was essentially unchanged compared to the same quarter of fiscal 2009 ended December 28, 2008.
Net Revenues by Product Line
The following chart details our net revenues by product line for the three months ended December 27, 2009 and December 28, 2008:
                                                 
    Net Revenues by Product Line  
    Three Months             Three Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decrease)     Change  
Host Server Products
  $ 81,923       76 %   $ 81,063       75 %   $ 860       1 %
Embedded Storage Products
    26,284       24 %     27,454       25 %     (1,170 )     (4 )%
Other
    83             144             (61 )     (42 )%
 
                                   
Total net revenues
  $ 108,290       100 %   $ 108,661       100 %   $ (371 )     %
 
                                   
HSP consists of HBAs, mezzanine cards, I/O ASICs, and UCNAs. For the three months ended December 27, 2009, our Fibre Channel based products still accounted for the vast majority of our HSP revenues. The increase in our HSP net revenue for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 was mainly due to an increase of approximately 16% in units shipped partially offset by a decrease of approximately 13% in average selling price.
ESP primarily consists of our InSpeed®, FibreSpy®, input/output controller solutions, and bridge and router products. The decrease in our ESP net revenue for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 was primarily due to a decrease in average selling price of approximately 14% partially offset by an increase in units shipped of approximately 12%.
Our Other category primarily consists of contract engineering services, legacy and other products.
Net Revenues by Major Customers
In addition to direct sales, some of our larger OEM customers purchase or market products indirectly through distributors, resellers or other third parties. If these indirect sales are purchases of customer-specific models, we are able to track these sales. However, if these indirect sales are purchases of our standard models, we are not able to distinguish them by OEM customer. Customers whose direct net revenues, or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties), exceeded 10% of our net revenues were as follows:
                                 
    Net Revenues by Major Customers  
    Direct Revenues     Total Direct and Indirect Revenues (2)  
    Three Months     Three Months     Three Months     Three Months  
    Ended     Ended     Ended     Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
Net revenue percentage (1):
                               
OEM:
                               
EMC
                12 %     14 %
Hewlett-Packard
    13 %     18 %     14 %     18 %
IBM
    23 %     23 %     33 %     30 %
 
     
(1)  
Amounts less than 10% are not presented.
 
(2)  
Customer-specific models purchased or marketed indirectly through distributors, resellers, and other third parties are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

 

22


Table of Contents

Direct sales to our top five customers accounted for approximately 58% of total net revenues for the three months ended December 27, 2009, compared to approximately 63% for the three months ended December 28, 2008. Our net revenues from customers can be significantly impacted by changes to our customers’ business and their business models. Direct and indirect sales to our top five customers accounted for approximately 72% of total net revenues for the three months ended December 27, 2009 compared to approximately 75% for the three months ended December 28, 2008. Our net revenues from customers can be significantly impacted by changes to our customers’ business and their business models.
Net Revenues by Sales Channel
Net revenues by sales channel were as follows:
                                                 
    Net Revenues by Sales Channel  
    Three Months             Three Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decrease)     Change  
OEM
  $ 91,194       84 %   $ 87,410       80 %   $ 3,784       4 %
Distribution
    16,992       16 %     21,173       20 %     (4,181 )     (20 )%
Other
    104             78             26       33 %
 
                                   
Total net revenues
  $ 108,290       100 %   $ 108,661       100 %   $ (371 )     %
 
                                   
The increase in OEM net revenues as a percentage of total net revenues was mainly due to end users migrating from purchasing our products through the distribution channel toward purchasing our products through OEM server manufacturers. We believe that our net revenues are being generated primarily as a result of product certifications and qualifications with our OEM customers, which take products directly and indirectly through distribution and contract manufacturers. We view product certifications and qualifications as an important indicator of future revenue opportunities and growth for the Company. However, product certifications and qualifications do not necessarily ensure continued market acceptance of our products by our OEM customers. It is also very difficult to determine the future impact, if any, of product certifications and qualifications on our revenues.
Net Revenues by Geographic Territory
Our net revenues by geographic territory based on billed-to location were as follows:
                                                 
    Net Revenues by Geographic Territory  
    Three Months             Three Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decrease)     Change  
United States
  $ 33,324       31 %   $ 41,499       38 %   $ (8,175 )     (20 )%
Asia Pacific
    40,172       37 %     28,084       26 %     12,088       43 %
Europe, Middle East, Africa and rest of the world
    34,794       32 %     39,078       36 %     (4,284 )     (11 )%
 
                                   
Total net revenues
  $ 108,290       100 %   $ 108,661       100 %   $ (371 )     %
 
                                   
We believe the decrease in United States net revenues and increase in Asia Pacific net revenues as a percentage of total net revenues for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 was primarily due to our OEM customers migrating towards using contract manufacturers located internationally, predominantly in Asia Pacific. However, as we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our net revenues may not be reflective of the geographic mix of end-user demand or installations.

 

23


Table of Contents

Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Gross Profit  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$66,784
    62 %   $ 65,985       61 %   $ 799       1 %
Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Cost of sales also included approximately $4.7 million of amortization of technology intangible assets for both the three months ended December 27, 2009 and December 28, 2008. Approximately $0.3 million and $0.4 million of share-based compensation expense was included in cost of sales for the three months ended December 27, 2009 and December 28, 2008, respectively. Gross margin increased during the three months ended December 27, 2009 primarily due to the gain in efficiencies resulting from higher manufacturing volume that was partially offset by a decline in average sales price. Even though gross margin increased in the three months ended December 27, 2009 compared to the three months ended December 28, 2008, we anticipate gross margin will trend downward over time as faster growing, lower gross margin products become a bigger portion of our business.
Engineering and Development. Engineering and development expenses consisted primarily of salaries and related expenses for personnel engaged in the design, development, and technical support of our products. These expenses included third-party fees paid to consultants, prototype development expenses, and computer service costs related to supporting computer tools used in the design process. Expenses for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Engineering and Development  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$31,680
    29 %   $ 31,101       28 %   $ 579       1 %
Engineering and development expenses for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 increased approximately $0.6 million, or 2%. Approximately $1.2 million and $2.6 million of share-based compensation expense was included in engineering and development costs for the three months ended December 27, 2009 and December 28, 2008, respectively. As a result of organizational changes in fiscal 2009, engineering and development headcount decreased to 450 at December 27, 2009 from 467 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $0.6 million in salary and related expenses as compared to the same period in fiscal 2009, offset by an increase in performance based compensation of approximately $1.0 million. Costs associated with new product development increased by approximately $3.2 million compared to the same period in fiscal 2009, partially offset by a decrease in technology spending of approximately $0.8 million, a decrease in depreciation expense of approximately $0.5 million, and a decrease in supplies and equipment expense of approximately $0.3 million.
Selling and Marketing. Selling and marketing expenses consisted primarily of salaries, commissions, and related expenses for personnel engaged in the marketing and sales of our products, as well as trade shows, product literature, promotional support costs, and other advertising related costs. Expenses for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Selling and Marketing  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$15,760
    15 %   $ 13,270       12 %   $ 2,490       3 %
Selling and marketing expenses for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 increased approximately $2.5 million, or 19%. Approximately $0.9 million and $1.0 million of share-based compensation expense was included in selling and marketing costs for the three months ended December 27, 2009 and December 28, 2008, respectively. Selling and marketing headcount decreased to 121 at December 27, 2009 from 135 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $0.7 million in salary and related expenses as compared to the same period in fiscal 2009, offset by an increase in performance based compensation of approximately $2.4 million. The remaining increase in expenses during the three months ended December 27, 2009 was partially due to an increase in outside services of approximately $0.4 million related to new product launches and promotional sponsorships. We will continue to target advertising, market promotions, and heighten brand awareness of our new and existing products in an effort to provide overall revenue growth.

 

24


Table of Contents

General and Administrative. Ongoing general and administrative expenses consisted primarily of salaries and related expenses for executives, financial accounting support, human resources, administrative services, professional fees, and other corporate expenses. Expenses for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
General and Administrative  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$11,896
    11 %   $ 9,548       9 %   $ 2,348       2 %
General and administrative expenses for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 increased approximately $2.3 million, or 25%. Approximately $1.2 million and $1.8 million of share-based compensation expense was included in general and administrative costs for the three months ended December 27, 2009 and December 28, 2008, respectively. General and administrative headcount decreased to 128 at December 27, 2009 from 139 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $0.8 million in salary and related expenses, offset by an increase in performance based compensation of approximately $1.0 million. The increase in general and administrative expenses was primarily due to litigation costs of approximately $4.1 million, partially offset by a decrease in outside services of approximately $0.7 million, a decrease in supplies and equipment expenses of approximately $0.3 million, and a decrease in travel and related expenses of approximately $0.2 million.
Amortization of Other Intangible Assets. Amortization of other intangible assets includes the amortization of intangible assets such as patents, customer relationships, tradenames, and covenants not-to-compete with estimable lives. Our amortization of expense for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Amortization of Other Intangible Assets  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$1,698
    2 %   $ 1,851       2 %   $ (153 )      
Amortization of other intangible assets for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 decreased approximately $0.2 million, or 8%. The decrease was due primarily to a lower unamortized balance of intangibles at the beginning of the current fiscal quarter.
Nonoperating (Expense) Income, net. Nonoperating (expense) income, net consisted primarily of interest income, interest expense and other non-operating income and expense items. Our nonoperating (expense) income, net for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Nonoperating (Expense) Income, net  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$(41)
        $ 1,063       1 %   $ (1,104 )     (1 )%
Our nonoperating (expense) income, net, for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 decreased approximately $1.1 million, or 104%. Included in nonoperating (expense) income is a foreign currency loss of approximately $0.1 million, partially offset by interest income. The net decrease was primarily due to a lower balance of investments combined with lower interest rates on investments.

 

25


Table of Contents

Income Taxes. Income taxes for the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Income Taxes  
Three Months Ended   Percentage of     Three Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$(3,233)
    (3 )%   $ 761       1 %   $ (3,994 )     (4 )%
Income taxes for the three months ended December 27, 2009 compared to the three months ended December 28, 2008 decreased approximately $4.0 million, or 525%. Our effective tax benefit rate was approximately 57% for the three months ended December 27, 2009 compared to an effective tax rate of approximately 7% for the three months ended December 28, 2008. The decrease in taxes was due primarily to a decrease of approximately $8.0 million related to global initiatives and a decrease of approximately $1.9 million related to share-based compensation, partially offset by an increase in taxes of approximately $5.9 million related to lower Federal research credits. Tax benefits from Federal research credits were higher during the three months ended December 28, 2008 due to a retroactive extension of the Federal research credit in October 2008 as part of the Emergency Economic Stabilization Act of 2008.
Six months ended December 27, 2009, compared to six months ended December 28, 2008
Net Revenues. Net revenues for the six months ended December 27, 2009, decreased by approximately $26.5 million, or 12%, to approximately $193.8 million compared to approximately $220.4 million for the six months ended December 28, 2008. We believe the decrease in net revenues was due primarily to a downturn in information technology spending resulting from the recent global economic downturn and related economic uncertainty for our customers and the storage networking market as a whole.
Net Revenues by Product Line
The following chart details our net revenues by product line for the six months ended December 27, 2009 and December 28, 2008:
                                                 
    Net Revenues by Product Line  
    Six Months             Six Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decreas)     Change  
Host Server Products
  $ 146,068       75 %   $ 162,266       74 %   $ (16,198 )     (10 )%
Embedded Storage Products
    47,558       25 %     57,818       26 %     (10,260 )     (18 )%
Other
    191             273             (82 )     (30 )%
 
                                   
Total net revenues
  $ 193,817       100 %   $ 220,357       100 %   $ (26,540 )     (12 )%
 
                                   
For the six months ended December 27, 2009, our Fibre Channel based products still accounted for the vast majority of our HSP revenues. The decrease in our HSP net revenue for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 was mainly due to a decrease in average selling price of approximately 11% partially offset by an increase in units shipped of approximately 1%.
The decrease in our ESP net revenue for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 was primarily due to a decrease in units shipped of approximately 10% combined with a decrease in average selling price of approximately 9%.

 

26


Table of Contents

Net Revenues by Major Customers
Customers whose direct net revenues, or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties), exceeded 10% of our net revenues were as follows:
                                 
    Net Revenues by Major Customers  
    Direct Revenues     Total Direct and Indirect Revenues (2)  
    Six Months     Six Months     Six Months     Six Months  
    Ended     Ended     Ended     Ended  
    December 27,     December 28,     December 27,     December 28,  
    2009     2008     2009     2008  
Net revenue percentage (1):
                               
OEM:
                               
EMC
                11 %     14 %
Hewlett-Packard
    14 %     17 %     15 %     17 %
IBM
    23 %     22 %     33 %     30 %
 
     
(1)  
Amounts less than 10% are not presented.
 
(2)  
Customer-specific models purchased or marketed indirectly through distributors, resellers, and other third parties are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.
Direct sales to our top five customers accounted for approximately 59% of total net revenues for the six months ended December 27, 2009, compared to approximately 62% for the six months ended December 28, 2008. Direct and indirect sales to our top five customers accounted for approximately 73% of total net revenues for both the six months ended December 27, 2009 and December 28, 2008. Our net revenues from customers can be significantly impacted by changes to our customers’ business and their business models.
Net Revenues by Sales Channel
Net revenues by sales channel were as follows:
                                                 
    Net Revenues by Sales Channel  
    Six Months             Six Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decrease)     Change  
OEM
  $ 163,481       84 %   $ 174,921       79 %   $ (11,440 )     (7 )%
Distribution
    30,203       16 %     45,291       21 %     (15,088 )     (33 )%
Other
    133             145             (12 )     (8 )%
 
                                   
Total net revenues
  $ 193,817       100 %   $ 220,357       100 %   $ (26,540 )     (12 )%
 
                                   
The increase in OEM net revenues as a percentage of total net revenues was mainly due to our customers migrating from purchasing our products through the distribution channel toward purchasing our products through OEM server manufacturers.
Net Revenues by Geographic Territory
Our net revenues by geographic territory based on billed-to location were as follows:
                                                 
    Net Revenues by Geographic Territory  
    Six Months             Six Months                    
    Ended     Percentage     Ended     Percentage              
    December 27,     of Net     December 28,     of Net     Increase/     Percentage  
(in thousands)   2009     Revenues     2008     Revenues     (Decrease)     Change  
United States
  $ 60,090       31 %   $ 81,298       37 %   $ (21,208 )     (26 )%
Asia Pacific
    69,338       36 %     60,558       27 %     8,780       14 %
Europe, Middle East, Africa and rest of the world
    64,389       33 %     78,501       36 %     (14,112 )     (18 )%
 
                                   
Total net revenues
  $ 193,817       100 %   $ 220,357       100 %   $ (26,540 )     (12 )%
 
                                   

 

27


Table of Contents

We believe the decrease in United States net revenues and increase in Asia Pacific net revenues as percentages of total net revenues for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 was primarily due to our OEM customers migrating towards using contract manufacturers located internationally, predominantly in Asia Pacific. The overall decrease in net revenues was due to the global economic slowdown that has resulted in decreased spending in general and in the technology sector specifically. However, as we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our net revenues may not be reflective of the geographic mix of end-user demand or installations.
Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Gross Profit  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$118,890
    61 %   $ 135,937       62 %   $ (17,047 )     (1 )%
Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Cost of sales also included approximately $9.5 million of amortization of technology intangible assets for both the six months ended December 27, 2009 and December 28, 2008. Approximately $0.7 million of share-based compensation expense was included in cost of sales for both the six months ended December 27, 2009 and December 28, 2008. Gross margin decreased during the six months ended December 27, 2009 primarily due to the loss of efficiencies resulting from lower manufacturing volume combined with a decline in average sales prices. We anticipate gross margin will trend downward over time as faster growing, lower gross margin products become a bigger portion of our business.
Engineering and Development. Engineering and development expenses consisted primarily of salaries and related expenses for personnel engaged in the design, development, and technical support of our products. These expenses included third-party fees paid to consultants, prototype development expenses, and computer service costs related to supporting computer tools used in the design process. Expenses for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Engineering and Development  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$63,079
    33 %   $ 65,884       30 %   $ (2,805 )     3 %
Engineering and development expenses for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 decreased approximately $2.8 million, or 4%. Approximately $3.7 million and $5.8 million of share-based compensation expense was included in engineering and development costs for the six months ended December 27, 2009 and December 28, 2008, respectively. As a result of organizational changes in fiscal 2009, engineering and development headcount decreased to 450 at December 27, 2009 from 467 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $3.7 million in salary and related expenses as compared to the same period in fiscal 2009, partially offset by an increase in performance based compensation of approximately $1.0 million. Costs associated with new product development increased by approximately $4.6 million compared to the same period in the fiscal 2009, partially offset by a decrease in technology spending of approximately $1.2 million, a decrease depreciation expense of approximately $0.6 million, and a decrease in supplies and equipment of approximately $0.7 million. The increase in engineering and development expenses as a percentage of revenues was primarily due to the relatively fixed amount of such expenses being spread over a lower net revenue base.

 

28


Table of Contents

Selling and Marketing. Selling and marketing expenses consisted primarily of salaries, commissions, and related expenses for personnel engaged in the marketing and sales of our products, as well as trade shows, product literature, promotional support costs, and other advertising related costs. Expenses for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Selling and Marketing  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$28,672
    15 %   $ 27,786       13 %   $ 886       2 %
Selling and marketing expenses for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 increased approximately $0.9 million, or 3%. Approximately $1.4 million and $2.0 million of share-based compensation expense was included in selling and marketing costs for the six months ended December 27, 2009 and December 28, 2008, respectively. Selling and marketing headcount decreased to 121 at December 27, 2009 from 135 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $1.5 million in salary and related expenses as compared to the same period in fiscal 2009, offset by an increase in performance based compensation of approximately $2.9 million. We will continue to target advertising, market promotions, and heighten brand awareness of our new and existing products in an effort to provide overall revenue growth. The increase in selling and marketing expenses as a percentage of revenues was primarily due to the relatively fixed amount of such expenses being spread over a lower net revenue base.
General and Administrative. Ongoing general and administrative expenses consisted primarily of salaries and related expenses for executives, financial accounting support, human resources, administrative services, professional fees, and other corporate expenses. Expenses for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
General and Administrative  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$24,175
    12 %   $ 18,964       8 %   $ 5,211       4 %
General and administrative expenses for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 increased approximately $5.2 million, or 27%. Approximately $2.8 million and $4.1 million of share-based compensation expense was included in general and administrative costs for the six months ended December 27, 2009 and December 28, 2008, respectively. General and administrative headcount decreased to 128 at December 27, 2009 from 139 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $0.7 million in salary and related expenses, offset by an increase in performance based compensation of approximately $1.4 million. The increase in general and administrative expenses was primarily due to litigation costs of approximately $6.7 million, partially offset by a decrease in outside services of approximately $1.4 million. The increase in general and administrative expenses as a percentage of revenues was primarily due to the relatively small increase in expenses being spread over a lower net revenue base.
Amortization of Other Intangible Assets. Amortization of other intangible assets includes the amortization of intangible assets such as patents, customer relationships, tradenames, and covenants not-to-compete with estimable lives. Our amortization of expense for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Amortization of Other Intangible Assets  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$3,396
    2 %   $ 3,938       2 %   $ (542 )      
Amortization of other intangible assets for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 decreased approximately $0.5 million, or 14%. The decrease was due primarily to a lower unamortized balance of intangibles at the beginning of the current fiscal period.
Nonoperating Income, net. Nonoperating income, net consisted primarily of interest income, interest expense and other non-operating income and expense items. Our nonoperating income, net for the six months ended December 27, 2009 and December 28, 2009 were as follows (in thousands):
                                         
Nonoperating Income, net  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$306
        $ 3,234       1 %   $ (2,928 )     (1 )%

 

29


Table of Contents

Our nonoperating income, net, for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 decreased approximately $2.9 million, or 91%. The net decrease was primarily due to a lower balance of investments combined with lower interest rates on investments.
Income Taxes. Income taxes for the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
                                         
Income Taxes  
Six Months Ended   Percentage of     Six Months Ended     Percentage of     Increase/     Percentage  
December 27, 2009   Net Revenues     December 28, 2008     Net Revenues     (Decrease)     Points Change  
$(12,906)
    (7 )%   $ 4,581       2 %   $ (17,487 )     (9 )%
Income taxes for the six months ended December 27, 2009 compared to the six months ended December 28, 2008 decreased approximately $17.5 million, or 382%. Our effective tax benefit rate was approximately 10,243% for the six months ended December 27, 2009 compared to an effective tax rate of approximately 20% for the six months ended December 28, 2008. The decrease in taxes was due primarily to a decrease of approximately $16.5 million related to global initiatives, a tax benefit of approximately $4.0 million related to the option exchange program, and a decrease of approximately $2.1 million related to share-based compensation, partially offset by an increase in taxes of approximately $5.3 million related to lower Federal research credits. Tax benefits from Federal research credits were higher during the six months ended December 28, 2008 due to a retroactive extension of the Federal research credit in October 2008 as part of the Emergency Economic Stabilization Act of 2008.
Critical Accounting Policies
The preparation of the condensed consolidated financial statements requires estimation and judgment that affect the reported amounts of net revenues, expenses, assets, and liabilities in accordance with accounting principles generally accepted in the United States. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying values of assets and liabilities.
We believe the following are critical accounting policies and require us to make significant judgments and estimates in the preparation of our condensed consolidated financial statements: revenue recognition; warranty; allowance for doubtful accounts; intangible assets and other long-lived assets; inventories; goodwill; income taxes; stock-based compensation; and litigation costs. Changes in judgments and uncertainties could potentially result in materially different results under different assumptions and conditions. If these estimates differ significantly from actual results, the impact to the consolidated financial statements may be material.
Revenue Recognition. We generally recognize revenue at the time of shipment when title and risk of loss have passed, evidence of an arrangement has been obtained, pricing is fixed or determinable, and collectibility has been reasonably assured (Basic Revenue Recognition Criteria). We make certain sales through two tier distribution channels and have various distribution agreements with selected distributors and Master Value Added Resellers (collectively, the Distributors). These distribution agreements may be terminated upon written notice by either party. Additionally, these Distributors are generally given privileges to return a portion of inventory and to participate in price protection and cooperative marketing programs. Therefore, we recognize revenue on our standard products sold to our Distributors based on data received from the Distributors and management’s estimates to approximate the point that these products have been resold by the Distributors. OEM-specific models sold to our Distributors are governed under the related OEM agreements rather than under these distribution agreements. We recognize revenue at the time of shipment for OEM specific products shipped to the Distributors when the Basic Revenue Recognition Criteria have been met. Additionally, we maintain accruals and allowances for price protection and various other marketing programs. We classify the costs of these incentive programs based on the benefit received, if applicable, as either a reduction of revenue, a cost of sale, or an operating expense.
Warranty. We provide a warranty of between one and five years on our products. We record a provision for estimated warranty related costs at the time of sale based on historical product return rates and management’s estimates of expected future costs to fulfill our warranty obligations. We evaluate our ongoing warranty obligation on a quarterly basis.

 

30


Table of Contents

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based upon historical write-offs as a percentage of net revenues and management’s review of outstanding accounts receivable. Amounts due from customers are charged against the allowance for doubtful accounts when management believes that collectibility of the amount is unlikely. Although we have not historically experienced significant losses on accounts receivable, our accounts receivable are concentrated with a small number of customers. Consequently, any write-off associated with one of these customers could have a significant impact on our allowance for doubtful accounts and results of operations.
Intangible Assets and Other Long-Lived Assets. Intangible assets resulting from acquisitions are carried at cost less accumulated amortization and impairment charges, if any. For assets with determinable useful lives, amortization is computed using the straight-line method over the estimated economic lives of the respective intangible assets, ranging from five to seven years. Furthermore, we assess whether our long-lived assets including intangible assets and equity investment in a privately-held company recorded under the cost method, should be tested for recoverability periodically and whenever events or circumstances indicate that their carrying value may not be recoverable. The amount of impairment, if any, is measured based on fair value, which is determined using projected discounted future operating cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs.
Inventories. Inventories are stated at the lower of cost, on a first-in, first-out basis, or market. We use a standard cost system for purposes of determining cost. The standards are adjusted periodically to represent actual cost. We regularly compare forecasted demand and the composition of the forecast against inventory on hand and open purchase commitments in an effort to ensure the carrying value of inventory does not exceed net realizable value. Accordingly, we may have to record reductions to the carrying value of excess and obsolete inventory if forecasted demand decreases.
Goodwill. Goodwill is not amortized, but instead is tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the assets might be impaired. Management considers our business as a whole to be its reporting unit for purposes of testing for impairment. This impairment test is performed annually during the fiscal fourth quarter. As of December 27, 2009, the fair value of the reporting unit substantially exceeded its carrying value.
A two-step test is used to identify the potential impairment and to measure the amount of goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill.
Income Taxes. We account for income taxes using the asset and liability method, under which we recognize deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for net operating loss and tax credit carryforwards. Tax positions that meet a more-likely-than-not recognition threshold are recognized in the financial statements.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. As a multinational corporation, we are subject to complex tax laws and regulations in various jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment, and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional liabilities or potentially to reverse previously recorded tax liabilities.

 

31


Table of Contents

Stock-Based Compensation. We account for our stock-based awards to employees and non-employees using the fair value method. Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. The fair value of each unvested stock award is determined based on the closing price of our common stock at grant date. For stock options, the measurement of stock-based compensation cost is based on several criteria including, but not limited to, the valuation model used and associated input factors such as expected term of the award, stock price volatility, dividend rate, risk free interest rate, and award forfeiture rate. The input factors to use in the valuation model are based on subjective future expectations combined with management judgment. If there is a difference between the forfeiture assumptions used in determining stock-based compensation costs and the actual forfeitures, which become known over time, we may change the assumptions used in determining stock-based compensation costs. These changes may materially impact our results of operations in the period such changes are made. See Note 10 in the accompanying notes to condensed consolidated financial statements contained elsewhere herein for additional information and related disclosures.
Litigation Costs. We record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. Legal and other litigation related costs are recognized as the services are provided. We record insurance recoveries for litigation costs for which both conditions are met: (i) the recovery is probable and (ii) collectability is reasonably assured. The insurance recoveries recorded are only to the extent the litigation costs have been incurred and recognized in the financial statements; however, it is reasonably possible that the actual recovery may be significantly different from our estimates. There are many uncertainties associated with any litigation, and we cannot provide assurance that any actions or other third party claims against us will be resolved without costly litigation and/or substantial settlement charges. If any of those events were to occur, our business, financial condition and results of operations could be materially and adversely affected.
Recently Adopted Accounting Standards
See Note 1 of Notes to Condensed Consolidated Financial Statements for a description of the recently adopted accounting standards.
Recently Issued Accounting Standards
See Note 1 of Notes to Condensed Consolidated Financial Statements for a description of the recently issued accounting standards we have not yet adopted.
Liquidity and Capital Resources
At December 27, 2009, we had approximately $334.2 million in working capital and approximately $268.8 million in cash and cash equivalents and current investments. At June 28, 2009, we had approximately $354.3 million in working capital and approximately $302.4 million in cash and cash equivalents and current investments. We invest in instruments that meet credit quality standards in accordance with our investment guidelines. We limit our exposure to any one issuer or type of investment with the exception of U.S. Government issued or U.S. Government sponsored entity securities. Our other investments consisted of term deposits and fixed income securities as of December 27, 2009 and we did not hold any auction rate securities or direct investments in mortgage-backed securities. We have primarily funded our cash needs from continuing operations. As part of our global initiatives, we currently plan to continue our strategic investment in research and development, sales and marketing, capital equipment, and facilities. We may also consider internal and external investment opportunities in order to achieve our growth and market leadership goals, including business acquisitions, licensing and joint-development agreements with our suppliers and other third parties.
In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0 million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover proposal and related tender offer of Broadcom Corporation to acquire us, our Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom’s announcement of its decision to allow its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. Through December 27, 2009, the Company has repurchased 2.0 million shares of its common stock for an aggregate purchase price of approximately $18.2 million or an average of $9.12 per share under this plan. Our Board of Directors has not set an expiration date for the plan.

 

32


Table of Contents

We believe that our existing cash and cash equivalents, current investments, and anticipated cash flows from operating activities will be sufficient to support our working capital needs and capital expenditure requirements for at least the next 12 months. We currently do not have any outstanding lines of credit or other borrowings.
Cash provided by operating activities during the six months ended December 27, 2009 was approximately $19.8 million compared to cash used in operating activities of approximately $10.7 million during the six months ended December 28, 2008. The current period cash provided by operating activities was primarily due to net income of approximately $12.8 million before adjustments of amortization of intangible assets of approximately $12.8 million, depreciation and amortization of approximately $10.6 million, and share-based compensation expense of approximately $8.6 million, partially offset by an increase in accounts and other receivables of approximately $16.7 million.
Cash used in investing activities during the six months ended December 27, 2009 was approximately $42.4 million compared to cash provided by investing activities of approximately $63.3 million during the six months ended December 28, 2008. The current period usage of cash was primarily due to a payment of approximately $20.0 million pursuant to a patent licensing arrangement with a third party and a $10.0 million loan to a privately-held company. See Notes 5 and 6 of Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q. We anticipate higher capital expenditures in the future as we continue to implement our global initiatives and grow our company.
Cash used in financing activities for the six months ended December 27, 2009 was approximately $18.8 million compared to approximately $38.3 million for the six months ended December 28, 2008. The current period usage of cash was primarily due to the purchase of treasury stock of approximately $18.2 million compared to approximately $39.9 million in the same period in the prior year.
We have disclosed outstanding legal proceedings in Note 8 to our condensed consolidated financial statements. Although we cannot be certain of the outcome of any litigation, we currently believe the final resolution of outstanding litigation will not have a material adverse effect on the Company’s liquidity or capital resources.
The following summarizes our contractual obligations as of December 27, 2009, and the effect such obligations are expected to have on our liquidity in future periods:
                                                         
    Payments Due by Period  
    (in thousands)  
            Remaining                                
    Total     2010     2011     2012     2013     2014     Thereafter  
Leases (1)
  $ 14,492     $ 3,080     $ 5,857     $ 3,907     $ 1,648     $     $  
Purchase commitments
    38,102       37,938       164                          
Other commitments (2)
    18,095       7,851       10,239       4       1              
 
                                         
Total
  $ 70,689     $ 48,869     $ 16,260     $ 3,911     $ 1,649     $     $  
 
                                         
 
     
(1)  
Lease payments include common area maintenance (CAM) charges.
 
(2)  
Consists primarily of commitments for professional fees of approximately $8.8 million, joint-development agreements of approximately $3.5 million, and non-recurring engineering services of approximately $3.0 million, but excludes approximately $32.5 million of unrecognized tax benefits under FIN 48 for which we cannot make a reasonably reliable estimate of the period of payment.

 

33


Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Our cash and cash equivalents are not subject to significant interest rate risk due to their short terms to maturity.  Cash equivalents include money market funds that invest in U.S. government securities and U.S. government sponsored entity securities. As of December 27, 2009, the carrying value of our cash and cash equivalents approximated fair value.
As of December 27, 2009, our investment portfolio of approximately $16.1 million consists primarily of term deposits and fixed income securities. We have the positive intent and ability to hold these investments to maturity.  We did not hold any auction rate securities or direct investments in mortgage-backed securities as of December 27, 2009.   The fair market value of our investment portfolio is subject to interest rate risk and would decline in value if market interest rates increased. If market interest rates were to increase immediately and uniformly by 10% from the levels existing as of December 27, 2009, the decline in the fair value of the portfolio would not be material to our financial position, results of operations and cash flows.
Foreign Currency Exchange Risk.
Our revenue and spending is transacted primarily in U.S. dollars; however, starting in fiscal 2009 we increased our transactions in other currencies to fund our global initiatives. As of December 27, 2009 and December 28, 2008, a 10% change in the value of the related currencies would not have a material impact on our results of operations and financial position.
Changes in exchange rates can also affect the volume of sales and the relative costs of operations based overseas.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.
There were no changes in our internal control over financial reporting that occurred during the three months ended December 27, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
Litigation
On November 15, 2001, prior to the Company’s acquisition of Vixel Corporation, a securities class action was filed in the United States District Court in the Southern District of New York as Case No. 01 CIV. 10053 (SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers and directors (one of which is James M. McCluney, the Company’s current Chief Executive Officer and President) and certain underwriters who participated in the Vixel initial public offering in late 1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section 11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties agreed to toll the statute of limitations with respect to Vixel’s officers and directors until September 30, 2003, and on the basis of this agreement, Vixel’s officers and directors were dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer defendants in the action reached a tentative settlement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the defendants and their officers and

 

34


Table of Contents

directors. In connection with the possible settlement, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements so that they would not expire prior to any settlement being finalized. Although Vixel approved this settlement proposal in principle, it remained subject to a number of procedural conditions, as well as formal approval by the court. On August 31, 2005, a Preliminary Order In Connection With Settlement Proceedings was issued by the court which among other items, set a date for a Settlement Fairness Hearing held on April 24, 2006, and the form of notice to the Settlement Classes of the Issuers’ Settlement Stipulation. In December 2005, the settlement notices authorized by the court were sent to former Vixel stockholders and the web site www.iposecuritieslitigation.com was created for claimants, as well as a March 24, 2006 objection deadline. At the Settlement Fairness Hearing held on April 24, 2006, the court raised the following primary issues: (1) the (possible) change in value of the settlement since preliminary approval, and whether the benefits of the settlement should be evaluated at the time of approval or at the time of negotiation; (2) how the class certification argument before the Second Circuit Court of Appeals could or would affect the fairness of the settlement; (3) how to evaluate the intangible benefits of the settlement to the class members; and (4) how to value the $1 billion guarantee (for the consolidated litigation involving Vixel and 297 other Issuers) by insurers in the stipulation and agreement of settlement in light of the underwriters’ potential future settlements. The Court did not rule on April 24, 2006 on the motion for final approval or objections. On June 6, 2006, the Second Circuit Court of Appeals held oral arguments on the appeal by the underwriters of Judge Scheindlin’s class certification decision. On or about July 17, 2006, Emulex assigned to the class action plaintiffs any IPO claims that Emulex (Vixel) had against RBC Dain Rauscher in the IPO litigation, as required by the settlement agreement. On December 5, 2006, the Second Circuit Court of Appeals issued a decision reversing Judge Scheindlin’s class certification decision. On December 14, 2006, Judge Scheindlin issued an order to stay all proceedings pending a decision from the Second Circuit on whether it will hear further argument. On about January 6, 2007, Emulex assigned to the class action plaintiffs any IPO claims that Emulex (Vixel) had against The Bear Stearns Companies Inc. and Bear Stearns & Co. Inc. in the IPO litigation, as required by the settlement agreement. On April 6, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of the decision denying class certification. During April 2007, counsel for Emulex and other Issuers informed Judge Scheindlin that, in light of the Second Circuit opinion, the settlement agreement could not be approved because the defined settlement class, like the litigation class, did not meet the Second Circuit requirements for certification. Judge Scheindlin held a conference on May 30, 2007 to consider issues relating to the class definitions, the statute of limitations, settlement, and discovery. On June 25, 2007, Judge Scheindlin signed a Stipulation and Order submitted by the parties which terminated the June 10, 2004 Stipulation and Agreement of Settlement with Defendant Issuers and Individuals. On June 26, 2007, a document production request from the plaintiffs to all 298 issuers (including Vixel) was received, covering documents from each issuer’s inception through December 31, 2001. In September 2007, due to the expiration of the tolling agreements, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements until August 27, 2010. On November 15, 2007, the issuers and their respective insurers entered into an Insurers-Insureds Agreement (replacing an earlier agreement), which provides for the insurers to pay for certain defense costs under applicable issuer insurance policies. On December 21, 2007, issuer defendants filed an opposition to plaintiffs’ motion for class certification of certain focus cases. On March 26, 2008, defendants’ motion to dismiss was denied except to certain claims by plaintiffs who did not suffer damages or whose claims were time barred. On Oct. 10, 2008, Judge Scheindlin signed an order granting the plaintiffs’ request to withdraw the class certification motion in the six focus cases (Emulex/Vixel is not in a focus case). On April 1, 2009, the parties signed a Stipulation and Agreement of Settlement (the 2009 Settlement) which the District Court subsequently approved on October 6, 2009. The 2009 Settlement provides for a settlement amount of $586 million, and Emulex has no obligation to pay any part of that amount. On October 23, 2009, Lester Baum, Mike Hart, and Sue Shadley filed a petition for permission to appeal the class certification order.
On January 27, 2009, a patent infringement lawsuit was filed in the United States District Court in the Central District of California as Case No. CV09-00605 R (JWJx) against Emulex by Microprocessor Enhancement Corporation and Michael H. Branigin. The complaint alleges infringement of U.S. Patent No. 5,471,593, and seeks a judgment for damages, injunctive relief, and an award of attorneys’ fees and costs. On March 25, 2009, Emulex filed an answer to the complaint denying allegations and asserting affirmative defenses. On Oct. 13, 2009, the Company filed documents opposing a summary judgment motion by the Plaintiffs. A hearing of the summary judgment motion was held on Nov. 16, 2009, and the motion was taken under submission.

 

35


Table of Contents

On April 27, 2009, Reid Middleton filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of himself and all other similarly situated stockholders of the Company and derivatively on behalf of the Company. The original complaint named the members of the Board as defendants and the Company as a nominal defendant. The complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of shares of the Company’s common stock (the Shares) and a derivative claim for devaluation of the Company stemming from the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its unsolicited April 21, 2009 takeover proposal to acquire the Company. The original complaint sought declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.
On May 6, 2009, Jim Robbins filed a lawsuit in the Superior Court of the State of California, County of Orange, on behalf of himself and all other similarly situated stockholders of the Company (the California Litigation). The complaint names the members of the Board and the Company as defendants. The complaint asserts a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory and injunctive relief, a constructive trust upon any benefits improperly received as a result of the alleged wrongful conduct and breach of any duty owed to the holders of Shares, and costs, including attorneys’ and expert fees. This lawsuit was dismissed without prejudice on December 15, 2009.
On May 7, 2009, Kamwai Fred Chan filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of himself and all other similarly situated stockholders of the Company. The complaint names the members of the Board and the Company as defendants. The complaint asserts a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.
On May 11, 2009, the Court of Chancery of the State of Delaware granted plaintiff Reid Middleton’s motion to expedite proceedings and set a trial date in the three foregoing Delaware lawsuits beginning on July 8, 2009. On July 6, 2009, the Court of Chancery continued the July 8, 2009 trial date indefinitely. On December 3, 2009, the plaintiff’s attorneys filed an application for an award of attorney’s fees and expenses. The Court rejected the plaintiff’s request for attorneys’ fees on December 18, 2009.
On May 11, 2009, Pipefitters Local No. 636 Defined Benefit Plan filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of itself and all other similarly situated stockholders of the Company and derivatively on behalf of the Company. The original complaint named the members of the Company’s Board as defendants and the Company as a nominal defendant. The complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The original complaint also asserted a derivative claim for breach of fiduciary duty based on the same actions. The original complaint sought declaratory and injunctive relief, including mandatory injunctive relief, and costs, including attorneys’ and expert fees.
On May 12, 2009, Norfolk County Retirement System filed a lawsuit in the Court of Chancery of the State of Delaware on behalf of itself and all other similarly situated stockholders of the Company. The original complaint named the members of the Company’s Board and the Company as defendants. The original complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to the Company’s January 2009 amendments to its Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The original complaint sought declaratory and injunctive relief, compensatory damages, interest and costs, including attorneys’ and expert fees.

 

36


Table of Contents

On September 17, 2009, Reid Middleton, Pipefitters Local No. 636 Defined Benefit Plan and Norfolk County Retirement System (together the Plaintiffs) filed a Verified Amended Class Action and Derivative Complaint in the Court of Chancery of the State of Delaware. The amended complaint is brought on behalf of Plaintiffs and all other similarly situated stockholders of the Company and, alternatively, derivatively on behalf of the Company. The complaint names the members of the Board as defendants and the Company as a nominal defendant. The complaint asserts claims for breach of fiduciary duty on behalf of a putative class of holders of Shares and, alternatively, a derivative claim for devaluation of the Company stemming from the Company’s January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in response to Broadcom’s announcement of its proposal to acquire the Company. The complaint seeks declaratory relief, compensatory damages, interest and costs, including attorneys’ and expert fees. On October 13, 2009, the defendants filed an answer to the amended complaint.
On September 14, 2009, Broadcom Corporation filed a patent infringement lawsuit against the Company in the United States District Court, in the Central District of California. The suit alleges that the Company is infringing 10 Broadcom patents covering certain data and storage networking technologies. The complaint seeks declaratory and injunctive relief, monetary damages, and interest and costs, including attorneys’ and expert fees. On November 4, 2009, the Company filed its answer and affirmative defenses to the patent infringement complaint alleging that it believes that the Broadcom patents at issue are invalid or not infringed, or both. In addition, the Company asserted counterclaims for declaratory judgment of invalidity and non-infringement against each of the Broadcom patents at issue, and seeks award of attorneys’ fees, costs, and expenses. On January 11, 2010, the Court set a trial date of September 20, 2011.
On November 9, 2009, the Company filed a lawsuit against Broadcom Corporation alleging that Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws, as well as made defamatory statements and engaged in acts of unfair competition. The complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief against Broadcom. On January 4, 2010, the Company filed an amended complaint. The amended complaint alleges that Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws and made defamatory statements. The amended complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief. Broadcom’s response to the amended complaint is due to be filed on February 4, 2010.
In addition to the ongoing litigation discussed above, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of the open matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.
Item 1A. Risk Factors
The recent economic downturn has resulted in a reduction in information technology spending in general, or spending on computer and storage systems in particular, that will adversely affect our revenues and results of operations in the near term and possibly beyond.
The demand for our network storage products has been driven by the demand for high performance storage networking products and solutions that support enterprise computing applications, including on-line transaction processing, data mining, data warehousing, multimedia, and Internet applications. The recent economic downturn and related disruptions in world credit and equity markets as well as the related failures of several large financial institutions have resulted in a global downturn in spending on information technology. If the downturn in the economy results in a significant downturn in demand for such products, solutions, and applications, it will adversely affect our business, results of operations, and financial condition in the near term and possibly beyond. The adverse effects of any sustained downturn in information technology spending on our operating results may be exacerbated by our research and development investments, strategic investments and merger and acquisition activity, as well as customer service and support, which are expected to continue despite any such downturn.

 

37


Table of Contents

Our markets are highly competitive and our business and results of operations may be adversely affected by entry of new competitors into the markets, aggressive pricing, and the introduction or expansion of competitive products and technologies.
The markets for our products are highly competitive and are characterized by rapid technological advances, price erosion, frequent new product introductions, and evolving industry standards. We expect that our markets will continue to attract new competition. Our current and potential competition consists of major domestic and international companies, some of which have substantially greater financial, technical, marketing, and distribution resources than we have. Additional companies, including but not limited to our suppliers, strategic partners, Original Equipment Manufacturer (OEM) customers, and emerging companies, may enter the markets for our storage networking products and new or stronger competitors may emerge as a result of consolidation movements in the marketplace. Additionally, our existing competitors continue to introduce products with improved price/performance characteristics, and we may have to do the same to remain competitive. Furthermore, competitors may introduce new products to the market before we do, and thus obtain a first to market advantage over us. Increased competition could result in increased price competition, reduced revenues, lower profit margins or loss of market share, any of which could have a material adverse effect on our business, results of operations, and financial condition.
A significant portion of our business depends upon the continued growth of the storage networking market and our business will be adversely affected if such growth does not occur, occurs more slowly than we anticipate, or declines.
The size of our potential market is largely dependent on the overall demand for storage in general and in particular upon the broadening acceptance of our storage networking technologies. We believe that our investment in multi protocol solutions that address the high performance needs of the storage networking market provides the greatest opportunity for our revenue growth and profitability for the future. However, the market for storage networking products may not gain broader acceptance and customers may choose alternative technologies that we are not investing in, and/or products supplied by other companies. Interest continues for other storage networking technologies such as Internet Small Computer Systems Interface (iSCSI), which may satisfy some Input/Output (I/O) connectivity requirements through standard Ethernet adapters and software at little to no incremental cost to end users. These software only iSCSI solutions compete with our Host Server Products, particularly in the low end of the market. We have also launched Converged Network Adapters (CNAs) using Fibre Channel over Ethernet (FCoE) or iSCSI protocols which may be used by the same customers impacting our Fibre Channel HBAs and mezzanine card revenues more than we anticipate. In addition, other technologies such as port bypass circuits (PBCs) and serial attached SCSI (SAS) compete with our embedded storage products today, and we may not be able to develop products fast enough or at a sufficiently low cost to compete in this market. Furthermore, since our products are sold as parts of integrated systems, demand for our products is driven by the demand for these integrated systems, including other companies’ complementary products. A lack of demand for the integrated systems or a lack of complementary products required for these integrated systems to be deployed could have a material adverse effect on our business, results of operations, and financial condition. If the storage networking market does not grow, grows more slowly than we anticipate, declines, attracts more competitors than we expect, as discussed below, or if our products do not achieve continued market acceptance, our business, results of operations, and financial condition could be materially adversely affected.
Because a significant portion of our revenues is generated from sales to a limited number of customers, none of which are subject to exclusive or long-term contracts, the loss of one or more of these customers, or our customers’ failure to make timely payments to us, could adversely affect our business.
We rely almost exclusively on OEMs and sales through distribution channels for our revenue. For both the three and six months ended December 27, 2009, we derived approximately 84% of our net revenues from sales to OEM customers and approximately 16% from sales through distribution. Furthermore, as some of our sales through distribution channels consist of OEM products, OEM customers effectively generated approximately 92% of our revenue for both the three and six months ended December 27, 2009, respectively. Moreover, direct sales to our top five customers accounted for approximately 58% and 59% for the three and six months ended December 27, 2009, respectively. We may be unable to retain our current OEM and distributor customers or to recruit additional or replacement customers.

 

38


Table of Contents

Although we have attempted to expand our base of customers, including customers for embedded storage products, we believe our revenues in the future will continue to be similarly derived from a limited number of customers. As a result, to the extent that sales to any of our significant customers do not increase in accordance with our expectations or are reduced or delayed, our business, results of operations, and financial condition could be materially adversely affected.
As is common in the technology industry, our agreements with OEMs and distributors are typically non-exclusive, have no volume commitments, and often may be terminated by either party without cause. It is increasingly commonplace for our OEM and distributor customers to utilize or carry competing product lines. If we were to lose business from one or more significant OEM or distributor customers to a competitor, our business, results of operations, and financial condition could be materially adversely affected. In addition, our OEMs may elect to change their business practices in ways that affect the timing of our revenues, which may materially adversely affect our business, results of operations, and financial condition.
Our operating results are difficult to forecast and could be adversely affected by many factors and our stock price may decline if our results fail to meet expectations.
Our revenues and results of operations have varied on a quarterly basis in the past and may vary significantly in the future. Accordingly, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful, and you should not rely on such comparisons as indications of our future performance. We may be unable to maintain our current levels of growth or profitability in the future. Our revenues and results of operations are difficult to forecast and could be adversely affected by many factors, including, but not limited to:
   
Changes in the size, mix, timing and terms of OEM and/or other customer orders;
 
   
Changes in the sales and deployment cycles for our products and/or desired inventory levels for our products;
 
   
Acquisitions or strategic investments by our customers, competitors or us;
 
   
Timing and market acceptance of new or enhanced product introductions by us, our OEM customers and/or competitors;
 
   
Market share losses or difficulty in gaining incremental market share;
 
   
Fluctuations in product development, procurement, resource utilization and other operating expenses;
 
   
Reduced demand from our customers if there is a shortage of, or difficulties in acquiring, components or other products, such as Fibre Channel or serial advanced technology attachment (SATA) disk drives and optical modules, used in conjunction with our products in the deployment of systems;
 
   
Inability of our electronics manufacturing service providers or suppliers to produce and distribute our products in a timely fashion;
 
   
Difficulties with updates, changes or additions to our information technology systems;
 
   
Breaches of our network security, including viruses;
 
   
Changes in general social and economic conditions, including but not limited to natural disasters, terrorism, public health crises, slower than expected market growth, reduced economic activity, delayed economic recovery, loss of consumer confidence, increased energy costs, adverse business conditions and liquidity concerns, concerns about inflation or deflation, recession, and reduced business profits and capital spending, with resulting changes in customer technology budgeting and spending;
 
   
Seasonality.

 

39


Table of Contents

As a result of these and other unexpected factors or developments, future operating results may be from time to time below the expectations of investors or market analysts, which would have a material adverse effect on our stock price.
A number of factors including relatively small backlog of unfilled orders, possible customer delays or deferrals and our tendency to generate a large percentage of our quarterly sales near the end of the quarter contribute to possible fluctuations in our operating results that could have an adverse impact on our results of operations and stock price.
Historically, we have generally shipped products quickly after we received orders, meaning that we do not always have a significant backlog of unfilled orders, in particular for our HBA products. As a result, our revenues in a given quarter may depend substantially on orders booked during that quarter. Alternatively, orders already in backlog may be deferred or cancelled. Also, we have typically generated a large percentage of our quarterly revenues in the last month of the quarter. As a result of our expense levels being largely based on our expectations of future sales and continued investment in research and development, in the event we experience unexpected decreases in sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. A material shortfall in sales in relation to our quarterly expectations or any delay, deferral, or cancellation of customer orders would likely have an immediate and adverse impact on our results of operations and may adversely affect our stock price.
Our industry is subject to rapid technological change, thus our results of operations could be adversely affected if we are unable to keep pace with the changes to successfully compete.
The markets for our products are characterized by rapidly changing technology, evolving industry standards, and the frequent introduction of new products and enhancements. Our future success depends in large part on our ability to enhance our existing products and to introduce new products on a timely basis to meet changes in customer preferences and evolving industry standards. Currently, new and proposed technologies such as eight and 16 Gb/s Fibre Channel solutions; FCoE; Enhanced Ethernet; 10 Gb/s Ethernet solutions; low latency Ethernet solutions; Data Center Ethernet; Infiniband; iSCSI; PCI-X 2.0; PCI Express Gen one, two, and three; PCI Express Advanced Switching; SATA; SAS; and Remote Direct Memory Access (RDMA); are in development by many companies and their ultimate acceptance and deployment in the market is uncertain. We are developing some, but not all of these technologies, and we cannot be sure that the technologies we chose to develop will achieve market acceptance, or that technologies that we chose not to develop will be available to purchase or license from third parties or will be immaterial to our business. Furthermore, if our products are not available in time for the qualification cycle at an OEM, we may be forced to wait for the next qualification cycle which is typically three years if at all. In addition, new products and enhancements developed by us may not be backwards compatible to existing equipment already installed in the market. If we are unable, for technological or other reasons, to develop new products, enhance or sell existing products, or consume raw materials in a timely and cost effective manner in response to technological and market changes, our business, results of operations, and financial condition may be materially adversely affected.
We have experienced losses in our history and may experience losses in our future that may adversely affect our financial condition.
We have experienced losses in our history, which may be caused by a downturn in the economy or an impairment of long-lived assets and/or goodwill. We may experience losses in the future due to an impairment of our long-lived assets, goodwill, and/or equity investments recorded under the cost method. To the extent that we are unable to generate positive operating profits or positive cash flow from operations, our financial condition may be materially adversely affected.
The timing of migration of our customers toward newer product platforms varies and may have a significant adverse effect.
As our customers migrate from one platform to the enhanced price/performance of the next platform, we may experience reduced revenue, gross profit, or gross margin levels associated with lower average selling prices or higher relative product costs associated with improved performance. While we regularly compare forecasted demand for our products against inventory on hand and open purchase commitments, to the extent that customers migrate more quickly than anticipated, the corresponding reduction in demand for older product platforms may result in excess or obsolete inventory and related charges which could have a material adverse effect on our financial condition and results of operations.

 

40


Table of Contents

The migration of our customers from purchasing our products through the distribution channel and toward OEM server manufacturers may have a significant adverse effect.
As our customers migrate from purchasing our products through the distribution channel and toward purchasing our products through OEM server manufacturers, which has a lower average selling price, this may have a material adverse effect on our financial condition and results of operations.
Any failure of our OEM customers to keep up with rapid technological change and to successfully market and sell systems that incorporate new technologies could adversely affect our business.
Our revenues depend significantly upon the ability and willingness of our OEM customers to commit significant resources to develop, promote, and deliver products that incorporate our technology. In addition, if our customers’ products are not commercially successful, it would have a materially adverse effect on our business, results of operations, and financial condition.
Rapid changes in the evolution of technology, including the unexpected extent or timing of the transition from HBA solutions or embedded switch box solutions to lower priced ASIC solutions, could adversely affect our business.
Historically, the electronics industry has developed higher performance application specific integrated circuits (ASICs) that create chip level solutions that replace selected board level or box level solutions at a significantly lower average selling price. We have previously experienced this trend and expect it to continue in the future. If this transition is more abrupt or is more widespread than anticipated, there can be no assurance that we will be able to modify our business model in a timely manner, if at all, in order to mitigate the effects of this transition on our business, results of operations, and financial position.
If customers elect to utilize lower-end HBAs in higher-end environments or applications, our business and financial condition could be negatively affected.
We supply three families of HBAs that target separate high-end, midrange and small to medium sized business user (SMB) markets. Historically, the majority of our storage networking revenue has come from our high-end server and storage solutions. In the future, increased revenues are expected to come from dual channel adapters, midrange server, and storage solutions, which have lower average selling prices per port. If customers elect to utilize midrange HBAs in higher-end environments or applications, or migrate to dual channel adapters faster than we anticipate, our business and financial condition could be negatively affected.
Advancement of storage device capacity technology may not allow for additional revenue growth.
Storage device density continues to improve rapidly and at some point in the future, the industry may experience a period where the advancement in technology may increase storage device capacity to a level that may equal or exceed the need for digital data storage requirements. This would result in a situation where the number of units of storage devices required in the marketplace may flatten out or even decrease. Our growth in revenue depends on growth in unit shipments to offset declining average selling prices. To the extent that growth in storage device unit demand slows or decreases, our financial condition and results of operations may be materially adversely affected.
A decrease in the average unit selling prices or an increase in the manufactured cost of our products due to inflation or other factors could adversely affect our revenue, gross margins and financial performance.
In the past, we have experienced downward pressure on the average unit selling prices of our products, and we expect this trend to continue. Furthermore, we may provide pricing discounts to customers based upon volume purchase criteria, and achievement of such discounts may reduce our average unit selling prices. To the extent that growth in unit demand fails to offset decreases in average unit selling prices, our revenues and financial performance could be materially adversely affected. Although we have historically achieved offsetting cost reductions, to the extent that average unit selling prices of our products decrease without a corresponding decrease in the costs of such products, our gross margins and financial performance could be materially adversely affected. Our gross margins could also be adversely affected by a shift in the mix of product sales to lower gross margin products. Furthermore, as our products are manufactured internationally, cost reductions would be more difficult to achieve if the value of the U.S. dollar continues to deteriorate. Moreover, if the manufactured cost of our products were to increase due to inflation or other factors and we cannot pass along the increase in our costs to our customers, our gross margins and financial performance could be materially adversely affected.

 

41


Table of Contents

Delays in product development could adversely affect our business.
We have experienced delays in product development in the past and may experience similar delays in the future. Prior delays have resulted from numerous factors, which may include, but are not limited to:
   
Difficulties in hiring and retaining necessary employees and independent contractors;
 
   
Difficulties in reallocating engineering resources and other resource limitations;
 
   
Unanticipated engineering or manufacturing complexity, including from third party suppliers of intellectual property such as foundries of our ASICs;
 
   
Undetected errors or failures in our products;
 
   
Changing OEM product specifications;
 
   
Delays in the acceptance or shipment of products by OEM customers; and
 
   
Changing market or competitive product requirements.
Given the short product life cycles in the markets for our products and the relatively long product development cycles, any delay or unanticipated difficulty associated with new product introductions or product enhancements could have a material adverse effect on our business, results of operations, and financial condition.
Our joint development activities may result in products that are not commercially successful or that are not available in a timely fashion.
We have engaged in joint development projects with customers, companies we have investments in, and third parties in the past and we expect to continue doing so in the future. Currently, we have investments in, receivables from, and commitments to various third parties related to these joint development efforts. Joint development can magnify several risks for us, including the loss of control over development of aspects of the jointly developed products and over the timing of product availability. Accordingly, we face increased risk that joint development activities will result in products that are not commercially successful or that are not available in a timely fashion. Any failure to timely develop commercially successful products through our joint development activities could have a material adverse effect on our business, results of operations, and financial condition.
A change in our business relationships with our third party suppliers or our electronics manufacturing service providers could adversely affect our business.
We rely on third party suppliers for components and the manufacture of our products, and we have experienced delays or difficulty in securing components and finished goods in the past. Delays or difficulty in securing components or finished goods at reasonable cost may be caused by numerous factors including, but not limited to:
   
Discontinued production by a supplier;
 
   
Required long-term purchase commitments;
 
   
Undetected errors, failures or production quality issues, including projected failures that may constitute epidemic failure rates specified in agreements with our customers or that may require us to make concessions or accommodations for continuing customer relationships;
 
   
Timeliness of product delivery;

 

42


Table of Contents

   
Sole sourcing and components made by a small number of suppliers, including the inability to obtain components and finished goods at reasonable cost from such sources and suppliers;
 
   
Financial stability and viability of our suppliers and electronics manufacturing service (EMS) providers;
 
   
Changes in business strategies of our suppliers and EMS providers;
 
   
Increases in manufacturing costs due to lower volumes or more complex manufacturing process than anticipated;
 
   
Disruption in shipping channels;
 
   
Natural disasters;
 
   
Inability or unwillingness of our suppliers or EMS providers to continue their business with us;
 
   
Environmental, tax or legislative changes in the location where our products are produced or delivered;
 
   
Difficulties associated with international operations; and
 
   
Market shortages.
There is a risk that we will not be able to retain our current suppliers or change to alternative suppliers. An interruption in supply, the cost of shifting to a new supplier or EMS providers, disputes with suppliers or EMS providers could have a material adverse effect on our business, results of operations, and financial condition.
As we have transitioned the material procurement and management for our key components used in our board or box level products to our EMS providers, we face increasing risks associated with ensuring product availability. Further, an adverse inventory management control issue by one or more of our third party suppliers could have a material adverse effect on our business, results of operations, and financial condition. We also purchase ASIC components from sole source suppliers, including LSI Corporation, Marvell Technology Group Ltd., Intel Corporation, and ServerEngines Corporation, who in turn rely on a limited number of their suppliers to manufacture ASICs, all of which create risks in assuring such component availability.
Unsolicited takeover proposals may be disruptive to our business and may adversely affect our operations; results and our ability to retain key employees.
On April 21, 2009, we received an unsolicited takeover proposal from Broadcom Corporation (Broadcom) to acquire all of our outstanding shares of common stock. While Broadcom has allowed its tender offer to expire, there can be no assurance that Broadcom or another third party will not make an unsolicited takeover proposal in the future. The review and consideration of any takeover proposal may be a significant distraction for our management and employees and could require the expenditure of significant time and resources by us.
Moreover, any unsolicited takeover proposal may create uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees and to hire new talent. Any such takeover proposal may also create uncertainty for our customers, suppliers and other business partners, which may cause them to terminate, or not to renew or enter into, arrangements with us. The uncertainty arising from unsolicited takeover proposals and any related costly litigation may disrupt our business, which could result in an adverse effect on our operating results. Management and employee distraction related to any such takeover proposal also may adversely impact our ability to optimally conduct our business and pursue our strategic objectives.

 

43


Table of Contents

We have entered into Key Employee Retention Agreements with four of our current executive officers, and adopted a Change in Control Retention Plan, in which currently an additional 23 key employees participate.  The participants of these retention arrangements may be entitled to severance payments and benefits, based on a period of between twelve months and two years, upon a termination of their employment by us without cause or by them for good reason in connection with a change of control of our company (each as defined in the applicable agreement or plan). These retention arrangements may not be adequate to allow us to retain critical employees during a time when a change in control is being proposed or is imminent.
If our intellectual property protections are inadequate, it could adversely affect our business.
We believe that our continued success depends primarily on continuing innovation, marketing, and technical expertise, as well as the quality of product support and customer relations. At the same time, our success is partially dependent on the proprietary technology contained in our products. We currently rely on a combination of patents, copyrights, trademarks, trade secret laws, and contractual provisions to establish and protect our intellectual property rights in our products.
We cannot be certain that the steps we take to protect our intellectual property will adequately protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology, or that we can maintain such technology as trade secrets. In addition, the laws of some of the countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all. Furthermore, we enter into various development projects and arrangements with other companies. In some cases, these arrangements allow for the sharing or use of our intellectual property. Our failure to protect our intellectual property rights could have a material adverse effect on our business, results of operations, and financial condition. We attempt to mitigate this risk by obtaining indemnification from others, where possible.
Certain of our software (as well as that of our customers) may be derived from “open source” software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License (GPL), which impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, or license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work.
Third party claims of intellectual property infringement could adversely affect our business.
We believe that our products and technology do not infringe on the intellectual property rights of others or upon intellectual property rights that may be granted in the future pursuant to pending applications. We occasionally receive communications from third parties alleging patent infringement, and there is always the chance that third parties may assert infringement claims against us. Any such claims, with or without merit, could result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements, which may or may not be available. Furthermore, we have in the past obtained, and may be required in the future to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable terms, our business, results of operations, and financial condition could be materially adversely affected.
Broadcom recently filed a patent infringement suit against us alleging that we are infringing on 10 Broadcom patents covering certain data and storage networking technologies. Ongoing lawsuits, such as the action brought by Broadcom present inherent risks, any of which could have a material adverse effect on our business, financial condition, or results of operations. Such potential risks include continuing expenses of litigation, risk of loss of patent rights, risk of injunction against the sale of products incorporating the technology in question, counterclaims, attorneys’ fees, and diversion of management’s attention from other business matters. See “Legal Proceedings” in Item 1, Part I of this Form 10-Q.

 

44


Table of Contents

The inability or increased cost of attracting, motivating, or retaining key managerial and technical personnel could adversely affect our business.
Our success depends to a significant degree upon the performance and continued service of key managers, as well as engineers involved in the development of our storage networking technologies and technical support of our storage networking products and customers. Competition for such highly skilled employees in the communities in which we operate, as well as our industry, is intense, and we cannot be certain that we will be successful in recruiting, training, and retaining such personnel. In addition, employees may leave us and subsequently compete against us, and there may be costs relating to their departure. Also, many of these key managerial and technical personnel receive stock options or unvested stock as part of our employee retention initiatives. The number of shares authorized under stock based plans may be insufficient and shareholders may not approve to increase the number of authorized shares. New regulations, volatility in the stock market, and other factors could diminish the value of our stock options or unvested stock, putting us at a competitive disadvantage and forcing us to use more cash compensation. If we are unable to attract new managerial and technical employees, or are unable to retain and motivate our current key managerial and technical employees, or are forced to use more cash compensation to retain or replace key personnel, our business, results of operations, and financial condition could be materially adversely affected.
Our international business activities subject us to risks that could adversely affect our business.
For the three and six months ended December 27, 2009, sales in the United States accounted for approximately 31% of our total net revenues, sales in Asia Pacific accounted for approximately 37% and 36% of our total net revenues, respectively, and sales in Europe, Middle East, Africa, and the rest of the world accounted for approximately 32% and 33% of our total net revenues, respectively based on billed-to address. We expect that our sales will be similarly distributed for the foreseeable future. However, because we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our sales may not be reflective of the geographic mix of end-user demand or installations. All of our sales are currently denominated in U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. In addition, an increasing amount of our expenses will be incurred in currencies other than U.S. dollars and as a result, we will be required from time to time to convert currencies to meet our obligations. Additionally, our suppliers are increasingly located outside the U.S., and a significant portion of our products is produced at our EMS providers’ production facilities in Thailand and Malaysia. Furthermore, in connection with the reorganization of our international subsidiaries, we established a company in Ireland, and a significant portion of our sales and operations will now also occur in countries outside of the U.S. As a result, we are subject to the risks inherent in international operations. Our international business activities could be affected, limited or disrupted by a variety of factors, including, but not limited to:
   
Imposition of or changes in governmental controls, taxes, tariffs, trade restrictions, and regulatory requirements to our current or future operations;
 
   
Costs and risks of localizing products for international countries;
 
   
Longer accounts receivable payment cycles;
 
   
Changes in the value of local currencies relative to our functional currency;
 
   
Fluctuations in freight costs and potential disruptions in the transportation infrastructure for our products and components;
 
   
Import and export restrictions;
 
   
Loss of tax benefits or increases in tax expenses;

 

45


Table of Contents

   
General economic and social conditions within international countries;
 
   
Taxation in multiple jurisdictions;
 
   
Difficulty maintaining management oversight and control of remote locations;
 
   
Potential restrictions on transferring funds between countries and difficulties associated with repatriating cash generated or held outside of the U.S. in a tax-efficient manner;
 
   
The increased travel, infrastructure, accounting, and legal compliance costs associated with multiple international locations; and
 
   
Political instability, war, or terrorism.
All of these factors could harm future sales of our products to international customers or production of our products outside of the United States, and have a material adverse effect on our business, results of operations, and financial condition.
Potential acquisitions or strategic investments may become more costly or less profitable than originally anticipated and may adversely affect the price of our common stock.
We may pursue acquisitions or strategic investments, including loans to private companies, that could provide new technologies, products, or service offerings. Acquisitions or strategic investments may negatively impact our results of operations as a result of operating losses incurred by the acquired entity, the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, incurrence of debt, amortization of intangible assets with determinable lives, or impairment of intangible assets. Furthermore, we may incur significant expenses pursuing acquisitions or strategic investments that ultimately may not be completed. Moreover, to the extent that any proposed acquisition or strategic investment that is not favorably received by stockholders, analysts and others in the investment community, the price of our stock could be adversely affected. In addition, acquisitions or strategic investments involve numerous risks, including, but not limited to:
   
Difficulties in the assimilation of the operations, technologies, products, and personnel of the acquired company;
 
   
Purchased technology that is not adopted by customers in the way or the time frame we anticipated;
 
   
Diversion of management’s attention from other business concerns;
 
   
Risks of entering markets in which we have limited or no prior experience;
 
   
Risks associated with assuming the legal obligations of the acquired company;
 
   
Losses incurred by our strategic investments that may be required to be reflected in our results;
 
   
Risks related to the effect that the acquired company’s internal control processes might have on our financial reporting and management’s report on our internal controls over financial reporting;
 
   
Potential loss of key employees of the company we invested in or acquired;
 
   
Risks related to companies we invest in not being able to secure additional funding, obtain favorable investment terms for future financings, or to take advantage of liquidity events such as initial public offerings, mergers, and private sales; and
 
   
There may exist unknown defects of an acquired company’s products or assets that may not be identified due to the inherent limitations involved in the due diligence process of an acquisition.

 

46


Table of Contents

In the event that an acquisition or strategic investment does occur and we are unable to obtain anticipated profits or successfully integrate operations, technologies, products, or personnel or acquire assets that later become worthless, our business, results of operations, and financial condition could be materially adversely affected.
Our stock price is volatile, which has and may result in lawsuits against us and our officers and directors.
The stock market in general and the stock prices in technology based companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future as well. For example, during calendar year 2009, the closing sales price of our common stock ranged from a low of $4.53 per share to a high of $12.28 per share. Factors that could have a significant impact on the market price of our stock include, but are not limited to, the following:
   
Quarterly variations in customer demand and operating results;
 
   
Announcements of new products by us or our competitors;
 
   
The gain or loss of significant customers or design wins;
 
   
Changes in analysts’ earnings estimates;
 
   
Changes in analyst recommendations, price targets, or other parameters that may not be related to earnings estimates;
 
   
Rumors or dissemination of false information;
 
   
Pricing pressures;
 
   
Short selling of our common stock;
 
   
General conditions in the computer, storage, or communications markets;
 
   
Events affecting other companies that investors deem to be comparable to us; and
 
   
Offers to buy us or a competitor for a premium over recent trading price.
In addition, Broadcom’s initiation and subsequent abandonment of its unsolicited takeover proposal to acquire all of the shares of our common stock has resulted in volatility in the price of our common stock. Any other takeover proposal by any third party to acquire the outstanding shares of our common stock may result in further volatility in the price of our common stock. If a takeover does not occur following announcement of a takeover proposal, for any reason, the market price of our common stock may decline. In addition, our stock price may decline as a result of the fact that we have been required to incur, and will continue to be required to incur, significant expenses related to the Broadcom unsolicited takeover proposal.
In the past, companies, including us, that have experienced volatility in the market price of their stock have been subject to securities class action litigation. If we were to be the subject of similar litigation in the future or experience unfavorable outcomes in any of our pending litigation, as discussed in Note 8 in the accompanying notes to our consolidated financial statements contained elsewhere herein, it could have a material adverse effect on our business, results of operations, and financial condition. Such litigation would also divert management’s attention from other business matters.
Terrorist activities and resulting military and other actions could adversely affect our business.
The continued threat of terrorism, military action, and heightened security measures in response to the threat of terrorism may cause significant disruption to commerce in some of the geographic areas in which we operate. Additionally, it is uncertain what impact the reactions to such events by various governmental agencies and security regulators worldwide will have on shipping costs. To the extent that such disruptions result in delays or cancellations of customer orders, delays in collecting cash, a general decrease in corporate spending on information technology, or our inability to effectively market, manufacture, or ship our products, our business, financial condition, and results of operations could be materially and adversely affected. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have any long-term material adverse effect on our business, results of operations, or financial condition.

 

47


Table of Contents

Our corporate offices and principal product development facilities are located in regions that are subject to earthquakes and other natural disasters.
Our California and Washington facilities, including our corporate offices and principal product development facilities, are located near major earthquake faults. Any disruption in our business activities, personal injury, or damage to the facilities in excess of our currently insured amounts as a result of earthquakes or other such natural disasters, could have a material adverse effect on our business, results of operations, and financial condition.
We currently do not carry earthquake insurance. However, we do carry various other lines of insurance that may or may not be adequate to protect our business.
Our certificate of incorporation, provisions of Delaware law, and any shareholders rights plan could adversely affect the performance of our stock.
Provisions of our certificate of incorporation and Delaware General Corporation Law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. In addition, although we have recently terminated our shareholders rights plan, it is possible that we may adopt a new shareholders rights plan in the future should general business, market and other conditions, opportunities and risks arise. The provisions of our certificate of incorporation, Delaware law, and any shareholders rights plan are generally intended to encourage potential acquirers to negotiate with us and allow our board of directors the opportunity to consider alternative proposals in the interest of maximizing shareholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price.
Our system of internal controls may be inadequate.
We maintain a system of internal controls in order to ensure we are able to collect, process, summarize, and disclose the information required by the Securities and Exchange Commission within the time periods specified. Any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Due to these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Additionally, public companies in the United States are required to review their internal controls under the Sarbanes-Oxley Act of 2002. If the internal controls put in place by us are not adequate or fail to perform as anticipated, we may be required to restate our financial statements, receive an adverse audit opinion on the effectiveness of our internal controls, and/or take other actions that will divert significant financial and managerial resources, as well as be subject to fines and/or other government enforcement actions. Furthermore, the price of our stock could be adversely affected.
Changes in laws, regulations, and financial accounting standards may affect our reported results of operations.
New laws, regulations and accounting standards, as well as changes to and varying interpretations of currently accepted accounting practices in the technology industry might adversely affect our reported financial results, which could have an adverse effect on our stock price.

 

48


Table of Contents

The final determination of our income tax liability may be materially different from our income tax provisions and accruals and our tax liabilities may be adversely affected by changes in applicable tax laws.
We are subject to income taxes in both the United States and international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Additionally, our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file.
We have adopted transfer-pricing procedures between our subsidiaries to regulate intercompany transfers. Our procedures call for the licensing of intellectual property, the provision of services, and the sale of products from one subsidiary to another at prices that we believe are equivalent to arm’s length negotiated pricing. We have established these procedures due to the fact that some of our assets, such as intellectual property, developed in the U.S., will be utilized among other affiliated companies. If the U.S. Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully require changes to our transfer pricing practices, we could become subject to higher taxes and our earnings would be adversely affected. Any determination of income reallocation or modification of transfer pricing laws can result in an income tax assessment on the portion of income deemed to be derived from the U.S. or other taxing jurisdiction.
Although we believe our tax estimates are reasonable, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. Should additional taxes be assessed as a result of new legislation, an audit or litigation, or determined in connection with finalization of our tax returns, or if our effective tax rate should change as a result of changes in federal, international or state and local tax laws or their interpretations, or if we were to change the locations where we operate or if we elect or are required to transfer funds between jurisdictions, there could be a material adverse effect on our income tax provision and net income in the period or periods in which that determination is made, and potentially to future periods as well.
We may need additional capital in the future and such additional financing may not be available on favorable terms.
While we believe we have adequate working capital to meet our expected cash requirements for the next 12 months, we may need to raise additional funds through public or private debt or equity financings in order to, without limitation:
   
Take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of complementary businesses or technologies;
 
   
Develop new products or services;
 
   
Repay outstanding indebtedness; and
 
   
Respond to unanticipated competitive pressures.
Any additional financing we may need may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of business opportunities, develop new products or services, or otherwise respond to unanticipated competitive pressures. In any such case, our business, results of operations, and financial condition could be materially adversely affected.
Global warming issues may cause us to alter the way we conduct our business.
The general public is becoming more aware of global warming issues and as a result, governments around the world are beginning to focus on addressing this issue. This may result in new environmental regulations that may unfavorably impact us, our suppliers, and our customers in how we conduct our business including the design, development, and manufacturing of our products. The cost of meeting these requirements may have an adverse impact on our results of operations and financial condition.

 

49


Table of Contents

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0 million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover proposal and related tender offer from Broadcom Corporation to acquire us, our Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom’s announcement of its decision to allow its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. Through December 27, 2009, the Company has repurchased 2.0 million shares of its common stock for an aggregate purchase price of approximately $18.2 million or an average of $9.12 per share under this plan. We may repurchase shares from time-to-time in open market purchases or privately negotiated transactions. The share repurchases will be financed by available cash balances and cash from operations. Our Board of Directors has not set an expiration date for the plan.
Issuer Purchases of Equity Securities
                                 
                    Total Number of     Approximate Dollar  
                    Shares Purchased as     Value of Shares  
    Total Number     Average     Part of Publicly     that May Yet Be  
    of Shares     Price Paid     Announced Plans     Purchased under the  
Period   Purchased     per Share     Or Programs     Plans or Programs  
September 28, 2009 — October 25, 2009
                    $ 81,760,136  
October 26, 2009 — November 22, 2009
                    $ 81,760,136  
November 23, 2009 — December 27, 2009
                    $ 81,760,136  
 
                           
Total
                    $ 81,760,136  
 
                           
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of the Company was held on November 19, 2009. There were 80,760,159 shares of the Company’s common stock issued, outstanding and entitled to vote at the meeting as of September 21, 2009, the record date. Proxies representing 66,019,964 common shares were received and tabulated. Two proposals were voted on at this meeting. First, the following members were elected to the Company’s Board of Directors to hold office for the ensuing year:
                 
Nominee   In Favor     Withheld  
Fred B. Cox
    59,939,380       6,080,584  
Michael P. Downey
    59,807,503       6,212,461  
Bruce C. Edwards
    59,773,278       6,246,686  
Paul F. Folino
    60,007,410       6,012,554  
Robert H. Goon
    59,727,080       6,292,884  
Don M. Lyle
    59,515,289       6,504,675  
James M. McCluney
    60,095,773       5,924,191  
Dean A. Yoost
    60,549,370       5,470,594  
The second proposal submitted to the stockholders of the Company was to ratify the selection of KPMG LLP as the Company’s independent registered public accounting firm for fiscal 2010. This proposal was approved with the following votes:
         
For
    65,099,478  
Against
    828,064  
Abstain
    92,422  
Broker non-votes
     

 

50


Table of Contents

Item 6. Exhibits
     
Exhibit 3.1  
Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s 1997 Annual Report on Form 10-K).
Exhibit 3.2  
Certificate of Amendment of Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2000).
Exhibit 3.3  
Amended and restated Bylaws of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 2, 2009).
Exhibit 3.4  
Amended and Restated Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock of Emulex Corporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 4.1  
Rights Agreement, dated as of January 15, 2009, with Mellon Investor Services LLC, as rights agent, which includes as Exhibit B the Form of Rights Certificate, incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 4.2  
Amendment to Rights Agreement, dated October 1, 2009, with Mellon Investor Services LLC, as rights agent, incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on October 2, 2009.
Exhibit 31A  
Certification of the Principal Executive Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31B  
Certification of the Principal Financial Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32  
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2002.

 

51


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: January 29, 2010
         
  EMULEX CORPORATION
 
 
  By:   /s/ James M. McCluney    
    James M. McCluney   
    President and Chief Executive Officer   
     
  By:   /s/ Michael J. Rockenbach    
    Michael J. Rockenbach   
    Executive Vice President and Chief Financial Officer
(Principal Financial and Chief Accounting Officer) 
 

 

52


Table of Contents

EXHIBIT INDEX
     
Exhibit 3.1  
Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s 1997 Annual Report on Form 10-K).
Exhibit 3.2  
Certificate of Amendment of Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2000).
Exhibit 3.3  
Amended and restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on October 2, 2009).
Exhibit 3.4  
Amended and Restated Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock of Emulex Corporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 4.1  
Rights Agreement, dated as of January 15, 2009, with Mellon Investor Services LLC, as rights agent, which includes as Exhibit B the Form of Rights Certificate, incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 4.2  
Amendment to Rights Agreement, dated October 1, 2009, with Mellon Investor Services LLC, as rights agent, incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on October 2, 2009.
Exhibit 31A  
Certification of the Principal Executive Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31B  
Certification of the Principal Financial Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32  
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2002.

 

53